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Exchange Rate Policies in Arab Countries:
Assessment and Recommendations
Dr. Philippe D. Karam
Economic Policy Institute
Arab Monetary Fund
Abu Dhabi, December 2001
AMF Economic papers are written by members of the Economic
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Arab Monetary Fund 2001.
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TABLE OF CONTENTS
ABSTRACT ---------------------------------------------------------------------1
I. INTRODUCTION -----------------------------------------------------------3
II. EXCHANGE RATE ARRANGEMENTS AND POLICIES:
THE CURRENT SITUATION------------------------------------------9
Exchange rates of Arab currencies: the “official” classification scheme--10
Exchange rates of Arab currencies: the newly revised IMF
classification scheme -------------------------------------------------------------15
A newly developed indicator of exchange rate flexibility-------------------17
Classification of Arab economies—based on level of development and
de facto exchange rate regimes -------------------------------------------------18
Evolution of exchange rate arrangements in general, and in Arab
countries in particular------------------------------------------------------------19
The case of Arab countries ------------------------------------------------------21
Measures of openness in Arab countries --------------------------------------25
Currency convertibility and capital controls in AMF countries------------26
Arab financial systems: a brief evaluation-------------------------------------31
Recent developments of exchange rates and policies in Arab countries---33
III. ASSESSMENT
Economic performance of Arab countries under alternative exchange
rate regimes
Inflation and growth--------------------------------------------------------------38
Measure of competitiveness -----------------------------------------------------43
Some theoretical hypotheses explaining the choice of exchange rate
regimes -----------------------------------------------------------------------------53
Are two sizes only fit for all Arab economies------------------------------- 53
Monetary regimes and corresponding operating frameworks---------------63
Exchange rate anchors in Arab economies: advantages and words of
caution------------------------------------------------------------------------------64
Nominal exchange rate anchors in AGCC countries-------------------------68
Exchange rate anchors in other Arab countries ------------------------------70
Other monetary policy frameworks in Arab economies ---------------------76
The role of the exchange rate under alternative monetary frameworks --78
IV. RECOMMENDATIONS FOR FUTURE DIRECTIONS ----------81
The euro and Association Agreements with the European Union
(AAEUs) ----------------------------------------------------------------------------83
The Arab countries: case-by-case ----------------------------------------------88
V. CONCLUSION---------------------------------------------------------------111
APPENDICES
Appendix A-------------------------------------------------------------------------118
Appendix B-------------------------------------------------------------------------127
BOXES
Box 1. Exchange Rate Regimes in Arab Gulf Cooperation Council
(AGCC) Countries ---------------------------------------------------------------12
Box 2. New IMF Exchange Rate classification System ---------------------121
Box 3. Monetary and Exchange Rate Policy and Operations, and
Issues in Capital Account Liberalization and Foreign Exchange
Intervention ------------------------------------------------------------------------57
Box 4. Transition Path and Exit Strategies Towards Exchange Rate
Flexibility --------------------------------------------------------------------------93
Box 5. Potential Exchange Rate Regimes in the Palestine Authority -----103
Box 6. Currency Boards: General Features------------------------------------105
TABLES
Table 1. Developing Arab Countries Grouped by Exchange Rate
Arrangements----------------------------------------------------------------------22
Table 2. Developing and Emerging Markets Arab Countries Grouped
by Exchange Rate Arrangements -----------------------------------------------24
Table 3.1. Indicators of Economic Integration --------------------------------29
Table 3.2. Measures of Exchange and Capital Controls in Non-High
Income AMF Countries ----------------------------------------------------------30
Table 3.3. Measures of Exchange and Capital Controls in High Income
Oil-Exporting AMF Countries --------------------------------------------------31
Table 4. Annual Rates of Change in the Consumer Price Index, Arab
Countries (1989-2000) -----------------------------------------------------------41
Table 5.Annual Growth Rates of Gross Domestic Product (%), Arab
Countries (1995-2000) -----------------------------------------------------------42
Table A1. Factors Affecting the Choice of Exchange Rate
Arrangements----------------------------------------------------------------------118
Table A2. Exchange Rate Systems in Arab Countries: Year 2000 --------119
Table A3. Exchange Rate Arrangements and Anchors of Monetary
Policy in Arab Countries (as of December 31, 2000) ------------------------120
Table A4. Country Scores on the FLT Index, 1998 (19 Arab
Countries) --------------------------------------------------------------------------124
Table A5. Exchange Rates: Domestic Currency per U.S. Dollar (period
average), 1992-2000 --------------------------------------------------------------125
Table A6. Official International Reserves of Arab Countries
(1995-2000)------------------------------------------------------------------------126
Table B1. Dollarization Rates (Foreign denominated deposits as a ratio
of domestic liquidity), end of December 1996-2000 -------------------------127
Table B2. Foreign Liabilities in Arab Commercial Banks (as a
percentage of total liabilities), end of period 1996-2000 --------------------127
FIGURES
Figure 1. Exchange Rate Regimes in Developing Arab Countries: 1991
(15 countries) and 1999, 2000 (17 countries) ---------------------------------23
Figure 2. Exchange Rate Regimes in Developing and Emerging
Markets Arab Countries: 1991 (17 countries) and 1999, 2000 (21
countries)---------------------------------------------------------------------------24
Figure 3. Annual Changes in Real Effective Exchange Rates and
Terms of Trade in Arab Countries: GCC countries (in percent) ------------49
Figure 4. Annual Changes in Real Effective Exchange Rates and
Terms of Trade in Arab Countries: Maghreb and Mashreq countries (in
percent) -----------------------------------------------------------------------------51
Figure 5. Export Indicators for Arab Countries-------------------------------52
REFERENCES ------------------------------------------------------------------128
Exchange Rate Policies in Arab Countries:
Assessment and Recommendations
Dr. Philippe D. Karam
Abstract
While being an important relative price in the economy, the exchange
rate itself is just one technical element in a broader monetary and
exchange rate operational framework. Consequently, the approach
adopted in evaluating the exchange arrangements must be integrative
in nature. As it follows, and in the context of Arab economies, issues
related to (a) maintaining internal and external stability (in terms of
demand management policies and exchange rate corrections to
preserve the viability of the balance of payments), (b) introducing
structural productivity-enhancing reform policies aimed at boosting
growth (via a more liberalized trade system, a stimulative environment
to foreign investment, timely privatization plans, or strategies aimed at
diversifying the production base of the economy to reduce dependence
on key commodities), (c) observing an internally consistent mix of
monetary and exchange rate policies and operations in light of a
globally integrated financial system, and (d) stressing the differences in
factor endowments, in economic structures and financial systems, were
closely scrutinized on a country-by-country basis. The central message
that emerged is that sound financial policies, supportive structural
2
policies particularly important in securing productivity gains, as well
as prudent demand management policies all work in a complementary
way to achieve the optimal exchange rate regime for a country.
Accompanying this message is a need for the authorities, in light of
changing economic conditions, to remain vigilant and flexible in
revising exchange rate arrangements on a timely basis. Despite the
commonality of language and culture in Arab countries, differences on
many economic and financial fronts were highlighted. It is hoped that
the meticulous review of the distinctive characteristics of the region’s
economies, will offer the concerned policymakers helpful clues
(stemming from tested experiences worldwide) as regards the need to
reform exchange systems, provided the suitable technical capacity to
undergo such reforms is already in place. Finally, in order to secure a
successful reform process without endangering macroeconomic and
financial stability, the pacing and the sequencing of steps involved
need to be carefully implemented.
3
I. Introduction
The exchange rate matters since it is an important price in the
economy. Changes can cause substantial reallocation of resources and
production between the tradeable and non-tradeable sectors of the
economy. But rarely is the exchange rate seen for what it is: a relative
price that, like any other, responds to the laws of supply and demand.
Being a price, the exchange rate according to simple economic theory
is therefore determined within the economic system—its significance
and behavior cannot be understood without paying attention to the
factors elsewhere in that system influencing it. Accordingly, one
cannot expect too much from “technical” arrangements, such as the
exchange regime. There is a need for sound financial policies, a need
for supportive structural policies and a need for continuity in the
efforts in achieving an optimal exchange rate regime in a country. Any
single exchange rate regime, on its own, cannot be considered a
credible substitute for sound underlying economic policies.
In this regard, the IMF emphasizes the need for greater coordination of
monetary and exchange rate policies (more so in light of increasing
capital mobility) in its key macroeconomic management area. An
“integrated approach” in advising on reforms of exchange systems is
put in place to highlight the linkages between stable and efficient
financial markets, an indirect or market-based approach to monetary
control, internally consistent macroeconomic and exchange rate
policies, and prudential supervision and regulations to address
(systemic) risks of threat to the financial system. Coordinating a
4
compatible and successful mix of macroeconomic policies and
supporting structural and financial policies is a formidable task ahead
of policymakers.
In close relation, the merits of alternative exchange rate regimes are
best debated in a coherent monetary order1 framework, when it comes
to the interaction of monetary and exchange policies. For instance, the
exchange rate and the exchange rate regime are but particular elements
in a broader set of arrangements referred to as the monetary order—
policy towards them should ideally be discussed coherently in this
broader context. It could be that problems with a less-than-coherent
monetary order and not the exchange rate regime itself that contribute
to a country’s economic difficulties2.
The economic literature3 has identified a number of factors relating to
(a) initial conditions (level of international reserves, macroeconomic
conditions); (b) structural characteristics (openness of the economy,
degree of capital mobility, degree of dollarization of financial system,
rigidity of the labor market, fiscal flexibility and sustainability,
soundness of banking system); (c) types of economic shocks facing the
1
2
3
D. Laidler (1999) “… a coherent order requires a well-defined goal for monetary
policy, one that the authorities are capable of achieving, and that anchors private
sector expectations. For it to be liberal, the relevant authorities should be accountable
to the electorate for their performance …”
The new IMF classification scheme of exchange rate arrangements acknowledges the
importance of this coherent strategy by classifying, side by side, members’ exchange
rate regimes and members’ choices of alternative nominal anchors in conducting
monetary policy. This is later illustrated for the case of Arab countries.
A brief summary of the “factors affecting the choice of exchange rate arrangement”
is given in Table A1 in appendix A.
5
economy (real or nominal, domestic or foreign); (d) policymakers’
economic objectives and supportive policies (stabilization, full
employment, competitiveness through export-oriented strategies,
incentives for domestic structural reforms, financial stability,
enhancing confidence4); and (e) non-economic criteria (such as
political factors and credibility of policies), as all having an influence
on the relative desirability of alternative exchange rate regimes. While
many approaches and models, (reflecting either “traditional” structural
criterion based on the optimal currency area view or more recent views
such as the “fear of floating” or the “political economy” view) are used
to investigate the importance of those factors in the selection of an
exchange rate regime, the conclusions they yield are not model-free. In
this respect, we review and assess certain aspects of traditional as well
as newer results in the context of Arab countries.
The growing consensus emerged among policymakers and academics
alike, that there may not be a single right choice for all (Arab)
countries when debating the merits of fixed and floating exchange rates
and their variations, rightly applies here5. Exchange rate arrangements,
for instance, will reflect the initial conditions and the objectives of
authorities, among other things. As the country’s economic conditions
evolve, it is required of policies to adjust on a timely and flexible basis.
4
5
For example through currency boards, monetary unions, full dollarization or more
pliant pegged regimes in certain cases.
It is also worth noting that the IMF advice to members reflects the ambiguity and
diversity of their exchange systems. Consistent with the Articles of Agreement, the
IMF generally respects the member’s choice exchange rate regime and advises on
policies needed to support that choice.
6
For example, despite their initial attraction, exchange rate pegs
eventually have to be abandoned, a process that is often messy. On the
other hand, as a country becomes more closely integrated into the
global financial system, a need evolves for some flexibility in the
exchange regime (provided the technical expertise in policymaking is
gained and other compensating adjustment mechanisms are inactive6).
Furthermore, the implementation of a flexible regime necessitates the
presence of active spot and forward foreign exchange market along
with a continuous interbank market supported by developed retail
markets (such as exchange houses and foreign exchange bureaus).
The paper is organized as follows. It begins by reviewing the exchange
rate arrangements currently in place in Arab countries. In Section II, an
emphasis is placed on separating the ‘words’ of officials from their
‘deeds’ in classifying exchange rate regimes. At least three different
classification schemes or indicators are reviewed and applied to the
countries in question. The “openness” of Arab economies is formalized
based on quantifiable economic integration indicators, and the stance
of Arab financial systems is briefly evaluated. It is understood that
sound financial systems and the integration of financial and economic
systems with those in the rest of the world are integral elements in
advising on the reforms of exchange systems. Section III begins with
an assessment of the economic performance of Arab economies with
6
The compensating adjustment mechanisms in an economics system are (a) labor
mobility, (b) wages flexibility, (c) fiscal transfers and, (d) the compensating role of
capital markets. As long as they cannot substitute for the automatic adjustment
feature of a flexible exchange rate regime, that regime will be important as a
component of the monetary order.
7
different exchange rate regimes by analyzing key macroeconomic
variables encapsulated in growth and inflation and by evaluating how
Arab countries as a group have fared in terms of competitiveness—to
this end, developments in real effective exchange rates, as a relevant
indicator, are analyzed. The hypotheses postulated in the literature to
explain the choice of exchange rate regimes are then reviewed in the
context of Arab economies. While the pegged regime emerges clearly
as a distinctive hallmark in Arab exchange rate regimes, an analysis of
its advantages and disadvantages is conducted. Thus, the contribution
of the paper lies in the analysis of “country specific” circumstances,
current as well as evolving ones—here, differences in the
developmental level of institutions and in the economics structures and
financial systems are dynamically thought-out on a country-by-country
basis. By doing so, we bring to the forefront what once was perceived
to be outside the purview of monetary-exchange rate policies. Attuning
the design of the institutions to the dynamics of the domestic political
and economic policy-making settings, and tailoring the means or steps
involved in the sequencing of exchange reforms to individual country
circumstances and needs, are carefully pursued. Once the situation is
assessed and subtle differentiating characteristics ranging from factor
endowments to economics structures are underlined (first, among Arab
regimes themselves, then between those regimes and the rest of the
world), recommendations are then presented in Section IV. The
recommendations
pertaining
to
the
relevant
exchange
rate
arrangements and the potential reforms therein are once again drawn in
light of countries’ specific characteristics. A forward-looking approach
is followed. While some recommendations are viewed as tentative,
8
others are decisively stated where clear evidence as regards the need to
reform prevails. The final Section V concludes by summing the paper
in pinpointing the more relevant policy issues and solutions
/recommendations.
9
II.
Exchange Rate Arrangements and Policies: The Current
Situation
This part reviews the current status of exchange rate arrangements and
policies in Arab countries7. A distinction is drawn between de
jure/official and de facto/true classification schemes as failure to
recognize the difference may lead to ignoring significant cross country
variation in exchange rate regime choice and may result in an
inconsistent mix of monetary and exchange rate policies.
The official classification of exchange rates is based on members’
notification of the exchange arrangements of their choice to the IMF,
which in turn summarizes them by an exchange rate classification
scheme first introduced in mid-1975 and regularly published since then
in the International Financial Statistics (IFS). The classification
scheme distinguished between three main groups: pegged exchange
rate arrangements, limited flexibility and more flexible arrangements8.
On the other hand, de facto classification is based on an assessment of
current policy implementation, rather than abiding by the country’s
official labeling of its regime.
7
8
The following Middle Eastern and North African countries are members of the Arab
Monetary Fund (AMF): Algeria, Bahrain, Comoros, Djibouti, the Arab Republic of
Egypt, Iraq, Jordan, Kuwait, Lebanon, the Palestine Authority, the Socialist People’s
Libyan Arab Jamahiriya, Mauritania, Morocco, Oman, Qatar, Saudi Arabia, Somalia,
Sudan, the Syrian Arab Republic, Tunisia, United Arab Emirates, and the Republic of
Yemen.
International Monetary Fund (1999). World Economic and Financial Surveys.
Exchange Rate Arrangements and Currency Convertibility, Developments and
Issues. Chapter 4, Box 1.
10
Exchange rates of Arab currencies: the “official” classification
scheme
The classification of members’ exchange rate arrangements (given in
Table A2 in appendix A)9 reflects the official declaration of country
authorities and does not necessarily reflect the de facto policies they
may follow. Therein, the exchange rate arrangements in Arab countries
are categorized in two main groups. The first group includes countries
that follow pegged exchange rate regimes (where the local currency is
either pegged to a single currency, or to currency composites—
standardized as in the case of the SDR or other weighted composites
formed from the currencies of major trading or financial partners). The
second group involves countries adopting more flexible forms of
exchange rate regimes (other managed or independent floating).
According to this classification, most Arab countries belong to the first
group as 12 of them follow a pegged regime. Five countries (Jordan10,
9
10
Source: Joint Arab Economic Report (2001), Appendix (10/10)—Arab Monetary
Fund.
Effective October 23, 1995, the Central Bank of Jordan (CBJ) amended its policy
with respect to determining the Jordanian Dinar (JD) exchange rate. Under this
amendment, priority was given to keeping the dinar's exchange rate stable against the
U.S. dollar and allowing it to fluctuate against other foreign currencies. The JD
exchange rate against the U.S. dollar was determined at an average rate of 709 fils.
The CBJ took this measure in order to impart greater transparency to the stability of
the JD exchange rate, and bolster the interest rate policy in its effort to enhance the
attractiveness of keeping assets denominated in JD against these denominated in U.S.
dollar. Monetary and in particular interest rate policy will continue to be guided
primarily by the objective of maintaining the stability of the JD… Central Bank of
Jordan (2000).
11
Djibouti, Syria, Iraq and Oman) peg to the U.S. dollar, whereby the
monetary authorities maintain a fixed exchange rate against the dollar
for all types of transactions. While Syria11 and Iraq maintain exchange
arrangement involving more than one market, the arrangement that is
categorized is the one maintained in the major market. Five other
countries (United Arab Emirates, Bahrain, Saudi Arabia, Qatar and
Libya) peg their currencies to the SDR. In the first four countries,
exchange rates are determined on the basis of a fixed relationship to
the SDR, within margins of up to ± 7.25 percent. However, because of
the maintenance of a relatively stable relationship with the U.S. dollar,
these margins are not always observed. On the other hand, the Libyan
dinar is allowed to fluctuate against the SDR within a wide band of ±
77.5 percent. More recently, the central bank of Libya adopted new
procedures allowing sharp consecutive devaluations of the official
exchange rate of the dinar against the dollar in an effort to narrow the
spread between the official exchange rate and the parallel market rate.
Under the pegged category, Kuwait and Morocco12 peg to a currency
composite. The currency is fixed daily based on variations in the value
of the currencies of the country’s principal trading partners where the
11
12
The multiple official rates in Syria are: (1) a legally designated official rate applies to
the repayment of loans and interests arising from bilateral payments agreements; (2)
the budget accounting rate (also known as the government free rate) applies to public
sector exports of petroleum, all government imports, and repayment of loans and
interest not related to bilateral payments agreements; and (3) the “rate in neighboring
countries” applying to eight different transactions types. This is contrasted with two
unofficial rates (1) the free market rate, and (2) the “exports proceeds” rate. An
assessment of the multiple currency practices (MCPs) in the context of the Syrian
economy is discussed later.
The emphasis in the case of Morocco is placed on the external competitiveness of the
economy, by tracking down the real effective exchange rate (REER).
12
weights reflect the relative importance of these currencies in the
country’s trade and financial relations—for instance, greater weights
are attached to the U.S. dollar (in the case of Kuwait) and to the euro
(in the case of Morocco, since the end of 1999).
Box 1. Exchange Rate Regimes in Arab Gulf Cooperation Council (AGCC) Countries
Saudi Arabia: Saudi riyal is officially pegged to the SDR at SRls 4.2826=SDR 1. The Saudi
riyal has been effectively pegged to the dollar at the fixed rate of SRls 3.745=U.S.$1 since June
1, 1986.
Qatar: Qatar riyal is officially pegged to the SDR at QR 4.7619=SDR 1. The Qatar riyal has
been effectively pegged to the dollar at the fixed rate of QR 3.6415=U.S.$1 since 1979.
Bahrain: Bahrain dinar is officially pegged to the SDR at BD 0.46190=SDR 1. The Bahrain
dinar has been effectively pegged to the dollar at the fixed rate of BD 0.3760=U.S.$1 since
December 198013.
U.A.E.: U.A.E. dirham is officially pegged to the SDR at Dh 4.7619=SDR 1. The U.A.E.
dirham has been effectively pegged to the dollar at the fixed rate of Dh 3.6710=U.S.$1 since
November 1980.
Oman: The Oman riyal is officially pegged to the dollar at the fixed rate of OR 0.3845=U.S.$1
since 1986.
Kuwait: The exchange value of the Kuwait dinar is determined on the basis of a fixed-butadjustable relationship between the dinar and a weighted basket of currencies, with the weights
reflecting the relative importance of these currencies in Kuwait’s trade and financial relations.
The Central Bank of Kuwait sets the rate for the dollar on the basis of the latest available
market quotation for that currency in relation to the other currencies included in the basket.
The dollar appears to have a very large weight in the currency basket. Between 1990 and 2000
the dinar was quite stable ranging between 0.2912 and 0.3067 KD for a U.S. dollar.
13
The Bahrain Monetary Agency recently announced that it has formally pegged the
dinar to the U.S. dollar, effective from December 25, 2001. The official exchange
rate will remain $2.659 to one dinar and the dollar will be sold by the agency to all
commercial banks in the archipelago at the rate of 377 fils. While making no change
to the current exchange rate, the move is likely to be viewed as adding transparency
to the agency’s actual exchange rate arrangement.
13
Box 1…continue
In late 2000, the AGCC countries decided to formalize a common peg to the dollar as an initial
step toward a possible common currency area in the future.
Source: Erbaş, Zubair and Sayers in I. Zubair (2001)
Regarding the second group of Arab countries adopting a floating
exchange rate regime, the number of countries following a managed
float has increased. In addition to Tunisia14, Algeria15 and Egypt16,
Lebanon17 and Mauritania18 more recently switched their exchange rate
14
15
16
17
The Tunisian authorities’ emphasis on using the exchange rate instrument to maintain
external competitiveness is well justified given that the exchange rate is largely
insulated from market pressures under tight capital controls. Tunisia targeted a stable
real effective exchange rate after 1992 (for e.g., depreciating its nominal exchange
rate by 4 percent annually relative to the dollar between 1992 and 1998). The main
competitiveness indicator followed by the authorities was a CPI-based real exchange
rate. The recent departure from the real exchange rate targeting rule observed in
2000, in an effort to develop and rely on a broader set of indicators to guide exchange
rate policy in the future, reflected the perceived limitations of the CPI-based real
exchange rate. Through the currency basket underlying its exchange rate policy,
Tunisia has links to EMU currencies.
The external value of the Algerian dinar is set on the interbank foreign exchange
market, which was established in early 1996. No margin limits are imposed on
buying and selling exchange rates in that market. There are rules on repatriation of
foreign exchange proceeds. In recent years, Algeria has pursued a fairly flexible
exchange rate policy mainly driven by reserve and economic diversification
objectives.
During 2000, seeking to strengthen external position, Egypt departed from the de
facto peg to the U.S. dollar adopted in early 1991. A devaluation (against the dollar)
was permitted reaching around 14% in 2000 with a high and low for the external
value of 3.42 and 3.89 respectively. Following an initial depreciation, an adjustable
currency band was adopted against the U.S. dollar in January 2001. This band was
subsequently further depreciated and widened in mid-2001.
During the last few years, Lebanon adopted a policy of fixing its exchange rate
within a narrow band fluctuating between 1501 and 1514 pounds against the U.S.
dollar.
14
classification from independent to managed float in an effort to capture
more adequately their choice of the exchange rate regime. The
managed floating regime aims at establishing a certain degree of
flexibility in exchange rates where the central bank quotes regularly
the exchange rate applied in foreign exchange interventions, according
to demand and supply conditions in the interbank markets as well as to
a set of indicators—more or less judgmental in nature. The central
banks also intervene by setting ceilings on the buy and sell rates
differential.
As for Arab countries adopting an independent float, the number has
been reduced lately to just three (Sudan, Somalia, and Yemen). The
rates therein are broadly market-determined. In the case of Sudan and
Yemen, the central bank determines a central parity rate against a
major currency (most often the U.S. dollar) and intervenes to meet the
markets’ needs for that currency and to influence the market—this is
aimed at avoiding excessive volatility and serious misalignment of the
exchange rate from an equilibrium level. Despite the monetary
authorities allowing the daily exchange rates to be market determined,
there is generally a need for active management to help guide the
market. This is due to financial markets not being highly developed in
the relevant country, often coupled with thin foreign exchange
markets, which may lead to considerable volatility in an unmanaged
market.
18
The central bank of Mauritania (BCM) is resolved to keep a maximum spread of 6%
between the official exchange rate and the parallel markets rate as is targeted under
the IMF program.
15
Exchange rates of Arab currencies: the newly revised IMF
classification scheme
The existing classification scheme suffers from important drawbacks19.
One drawback is that by lumping several inherently different regimes
in few traditional categories, the wide spectrum of regimes with
various degree of monetary policy independence is not always
apparent and suffers from considerable ambiguity. This has become a
more critical issue in an environment where consistency of monetary
and exchange rate policies are a key concern in avoiding excessive
short-term capital flows.
Another shortcoming of the present classification scheme is that there
is no adjustment for possible discrepancies between official/de jure and
true/de facto policies, such as the de facto peg of East Asian currencies
to the U.S. dollar until the time the Asian crisis erupted in 1997.
Among Arab countries, this is illustrated by a group of countries that
are classified as following managed or independently floating regimes
but use a range of different approaches to limit the flexibility of the
exchange rate. Egypt (until just recently) and Lebanon are two related
examples—they have a de facto peg under an announced managed or
independently floating arrangement20. The source of these differences
19
International Monetary Fund (1999).
16
could stem from either political economy considerations or from policy
dilemmas in terms of the trade-offs between economic objectives
facing authorities. However, classifying exchange rate arrangements
based on de facto policies could bring greater transparency to
members’ policies in particular to the role of their exchange rate
regimes in the overall policy framework. This also contributes to
improving the IMF surveillance over the countries’ exchange rate
policies.
The newly revised IMF classification scheme, available since
December 31st 1997 only and published in the IFS since April 1999,
distinguishes between the more rigid forms of pegged regimes (such as
currency boards); other (conventional) fixed peg arrangements against
a single currency or a currency basket; exchange rate bands around a
fixed peg; crawling peg arrangements; and exchange rate bands around
crawling pegs. A “no separate legal tender” category is also
introduced. Managed floats with a preannounced path are also
distinguished from other managed and free float. This classification
scheme also adjusts for possible discrepancies between de jure and de
facto policies. For the case of exchange rate arrangements in Arab
countries, the revised classification scheme is presented in (Table A3
in appendix A21). It is worth noting that “pegged” exchange rate
20
21
Although Lebanon has recently changed its official classification from an
independent to a managed float it remains, de facto, considered to be a pegged
regime. On the other hand, the more recent change in Egypt’s exchange rate policy,
evidenced through the latest rounds of serious depreciations, has moved the exchange
rate arrangement more and more toward a (managed) float regime.
The source of the table is the “International Financial Statistics”, June 2001
(reflecting countries’ regimes as of December 31, 2000). The reader may refer to
17
arrangements, in which the exchange rate plays the role of the nominal
anchor of monetary policy, prevail as the dominant type of monetary
arrangements in Arab countries (14 out of 21 countries).
A newly developed indicator of exchange rate flexibility
In complementing the newly revised IMF classification scheme,
Poirson (2001) develops and uses an alternative flexibility index (FLT
index) based on movements in exchange rates and international
reserves. The index ranks countries on a continuous scale of exchange
rate flexibility rather than lumping them in arbitrarily defined
categories. The calculation of the index itself is further explained in
(Table A4 in appendix A) where the scores on the FLT index in Arab
countries for the 12 months to December 1998 are reported. As
expected, Sudan for example an independent floater scored highly
while Djibouti a currency board country scored very low (zero).
However, the FLT index confirms the existence of discrepancies
between de jure and de facto exchange rate arrangements, beyond the
adjustments already made in the revised IMF scheme. Yemen, for
instance, classified as an independent floater has a relatively low
(rather than an expected large) score on the FLT index. This is just to
say that empirical results pertaining to the choice of exchange rate
regimes must be tentative in nature, until further improvements are
done to the indicators.
IMF (1999), Box 2—reproduced in the appendix—, for a detailed explanation of the
various exchange rate regimes listed in the revised scheme.
18
Classification of Arab economies—based on level of development
and de facto exchange rate regimes22
Out of 21 AMF member countries under consideration, (17) are
classified as “developing” while four (namely, Egypt, Jordan, Morocco
and Qatar) are classified as “emerging market”, with no other country
in the membership categorized as a “developed-market”23. The
exchange rate classification on the other hand, is based on the IMF
staff’s view of the de facto exchange rate arrangement in place on the
relevant date. As shown in Table A3, the exchange rate regimes are
split into three broad categories: (1) the “hard pegs” group consists of
economies with currency boards or those with no separate currency;
(2) the “intermediate” group consists of economies with conventional
fixed pegs, crawling pegs, horizontal bands, and crawling bands—
these will sometimes be referred to as “soft pegs” as they are softer and
more pliant systems than the hard pegs; and (3) the “floating” group
consists of economies whose systems are described either as a
managed float with no specified central rate, or as independently
floating.
22
23
The tables and figures presented are based on Fischer (2001) and on the IFS (June
2001), with an emphasis on Arab economies. See also the IMF’s Annual Report 2000
(pp 141-143) for a specification of the exchange rate categories.
This is based on classifications by Morgan Stanley Capital International Indices and
J.P. Morgan Emerging Markets Bond Index Plus (1998). The classification by other
institutions may differ somewhat.
19
Evolution of exchange rate arrangements in general, and in Arab
countries in particular
Before focusing on the Arab countries, major trends in exchange rate
arrangements in IMF members’ economies are first highlighted. This is
done to bring out in a contrasting way the distinctive hallmark of the
exchange rate regimes in Arab economies. As will be seen and later
discussed in greater details, the relevant exchange rate regimes
followed are predominantly of the pegged-but-adjustable nature. The
reasons behind the popular use of such a regime are attributed in large
to the specific characteristics of the economies under review, explained
further in more details in the sections to follow.
A change in the distribution of exchange rate arrangements among all
IMF members during the 1990s is summarized in the following table.
The table provides clear evidence that countries are moving away from
the center in support of the bi-polar or the two-corner solution view24,
a phenomenon known as the “hollow middle”.
24
Fischer (2001) …The new conventional wisdom has it that, particularly in view of
the high degree of capital mobility, countries will increasingly move toward the ends
of the spectrum that ranges from pure floating to hard pegs. Intermediate policy
regimes (representing a variety of soft pegging exchange rate arrangements) between
hard pegs and floating are not sustainable. This view states, more correctly, that for
countries open to international capital flows: (i) pegs are not sustainable unless they
are very hard indeed; but (ii) that a wide variety of flexible rate arrangements are
possible; and (iii) that it is to be expected that policy in most countries will not be
indifferent to exchange rate movements.
20
All IMF
1991
1999
2000
Member
(159 countries)
(185 countries)
(186 countries)
Hard Peg
16%
24%
25%
Intermediate
62%
34%
33%
Float
23%
42%
42%
Countries
For developed and emerging market countries, adjustable peg
exchange rate systems have not proved to be viable for the long term,
and should not be expected to be viable. These are exchange rate
systems for countries integrated or integrating into global capital
markets. Within the group of IMF emerging market countries, the
following table illustrates this tendency to shift away from
intermediate, soft peg, regimes, towards both greater fixity and greater
flexibility.
All IMF Emerging
1991
1999
Markets Countries
(33 countries)
(33 countries)
Hard Peg
6%
9%
Intermediate
64%
42%
Float
30%
48%
As for exchange rate arrangements in developing countries not open to
international capital flows, the table demonstrates a change in the
distribution of these arrangements over the decade of the 1990s, which
is remarkably similar in appearance to that of the emerging market
countries.
21
All IMF
1991
1999
Developing Countries
(104 countries)
(130 countries)
Hard Peg
21%
24%
Intermediate
60%
37%
Float
19%
39%
The case of Arab countries
The evidence just presented above detects clearly a so-called
“hollowing-out”
effect
in
exchange
rate
arrangements.
The
“developing” Arab economies group, taken alone, or when put together
with the four listed “emerging markets” Arab economies, in either case
shows that the number of intermediate arrangements has declined, and
the number of floaters has risen. However, this “hollowing of the
middle” while present is not as pronounced (in comparison to other
economies around the world), as the intermediate group remains
always the dominant arrangement followed to date25.
25
Recently, an issue was raised as to whether the virtual stability in the Sudanese
currency may have developed perceptions in the market that the exchange rate is
effectively fixed. In Yemen, one-sided intervention in foreign exchange market by
authorities may have undermined their efforts in allowing the exchange rate to be
fully market determined. A casting doubt about the true flexibility of exchange rate
regimes in Sudan and Yemen renders the “hollowing of the middle” in the
distribution of exchange rate arrangements even less evident than what Figures 1 and
2 depict.
22
Table 1. Developing Arab Countries
Grouped by Exchange Rate Arrangements
Exchange rate Regime
Countries
Countries
(Number
(as of December 1999)
(as of December 2000)
NS/CBA
(1) Djibouti
(1) Djibouti
FP
(9) Bahrain, Comoros,
(9) Bahrain, Comoros, Iraq,
Iraq,
Kuwait,
of
Arab
countries:(17))
Kuwait,
Lebanon,
Oman,
Lebanon, Oman, Saudi
Saudi Arabia, Syria, United
Arabia, Syria, United
Arab Emirates
Arab Emirates
HB
(1) Libya
(1) Libya
CP
(1) Tunisia
(0)
CB
(0)
(0)
MF
(2)
IF
Algeria,
(4)
Algeria,
Mauritania,
Mauritania
Sudan, Tunisia
(3) Somalia, Sudan,
(2) Somalia, Yemen
Yemen
23
NS = Arrangements with No Separate legal tender
CBA = Currency Board Arrangement
FP = Other conventional Fixed Pegs
HB = Pegged rate in Horizontal Band
CP = Crawling Peg
CB = Rates within Crawling Bands
MF = Managed Float with no pre-announced exchange rate path
IF
= Independently Floating
Figure 1. Exchange Rate Regimes in Developing Arab Countries
1991 (15 countries ) and 1999 , 2000 (17 countries )
90 %
Number of
countries as
a percentage
of total
12
:
81 %
80 %
11
70 %
65 %
59 %
60 %
10
50 %
5
35 %
29 %
40 %
30 %
20 %
10 %
1
1
2
1
13 %
6 % 6 %6 %
0%
Hard Peg
Intermediate
1991
1999
Float
2000
6
24
Table 2. Developing and Emerging Markets Arab Countries
Grouped by Exchange Rate Arrangements
Exchange
rate
Regime
(Number of Arab
countries:(21))
NS/CBA
FP
HB
CP
CB
MF
IF
Countries
(as of December
1999)
Countries
(as of December 2000)
(1) Djibouti
(13)
Bahrain,
Comoros,
Egypt,
Jordan, Iraq, Kuwait,
Lebanon,
Morocco,
Oman, Qatar, Saudi
Arabia, Syria, United
Arab Emirates
(1) Libya
(1) Tunisia
(0)
(2)
Algeria,
Mauritania
(1) Djibouti
13) Bahrain, Comoros,
Jordan, Iraq, Kuwait,
Lebanon,
Morocco,
Oman,
Qatar,
Saudi
Arabia, Syria, United
Arab Emirates
(3) Somalia, Sudan,
Yemen
(1) Libya
(0)
(0)
(5)
Algeria,
Egypt,
Mauritania,
Sudan,
Tunisia
(2) Somalia, Yemen
Figure 2. Exchange Rate Regimes in Developing and
Emerging Markets Arab Countries: 1991 (19 countries)
84
90%
(16)
71%
80%
70%
(5)
62%
60%
Number of
countries as a 50%
percentage of 40%
total
30%
20%
10%
(7)
(5)
33%
24%
(1)
(1)
(1)
(2)
11%
5% 5% 5%
0%
Hard Peg
1991
Intermediate
1999
2000
Float
25
Measures of openness in Arab countries
The IMF maintains and publishes information on members’ exchange
systems in the context of the Annual Report on Exchange
Arrangements and Exchange Restrictions (AREAER), focusing on the
regulations affecting current international transactions and lately
expanding the coverage to the capital account transactions. Data on the
number of transaction types controlled are intended to provide an
indicator of the overall degree of openness of the economy to capital
movements. The formalization of the measures of openness is effected
through the development of more inclusive restrictiveness indices. For
this purpose, the Fund developed indices of controls on current
payments and transfers denoted by (CCI), indices of capital controls
denoted by (KCI), and indices of exchange and capital controls
denoted by (ECI). The latter index is an average of the two former
indices and represents an overall measure of controls. These however
reflect the de jure instead of de facto incidence of controls.
26
Currency convertibility and capital controls in AMF countries26,27
Table A2 indicate that most Arab economies (14) have accepted
Article VIII. While Egypt and Libya allow for the convertibility of
current payments, they haven’t as of yet officially accepted Article
VIII. On the other hand, both Syria and Libya still apply multiple
exchange rates for various purposes, falling short of meeting Article
VIII requirements.
In assessing the extent of exchange and capital controls, the AMF
group of countries is split into two groups (i) high-income oil
exporting countries, and (ii) other AMF countries. As illustrated in
26
27
-
Three articles in the IMF Articles of Agreements are relevant. Article VIII requires
member countries to (i) avoid exchange restrictions on current payments; (ii) avoid
discriminatory or multiple exchange currency practices; (iii) permit the convertibility
of foreign-held balances of its currency for current account transactions, and (iv)
provide information to the IMF. Article XIV states that for a transitional period,
countries may maintain and adapt restrictions on payments and transfers for
international transactions that were in place when the country became a member of
the IMF (most countries have given up restrictions approved under Article XIV and
have accepted the obligations of Article IV). As for restrictions on capital account,
Article VI dealing with such matters (i) explicitly permits member countries to
exercise controls over international capital movements, provided such controls do not
unduly delay transfers of funds in settlement of commitments (with certain
exceptions); (ii) the Fund may even request a member to impose capital controls
(never used). Consideration has been given to amending the Articles of Agreement to
make elimination of capital controls a purpose of the IMF and to require members to
eliminate capital controls. This has not gone unchallenged in the wake of the latest
East Asian financial turmoil.
Joint Arab Economic Report (2001), Appendix (10/10)—Arab Monetary Fund.
-Annual Report on Exchange Arrangements and Exchange Restrictions, AREAER,
(2000)—IMF.
-World Economic Outlook, October 2001: Chapter IV “International Financial
Integration and Developing Countries”—IMF.
27
Tables 3.1, 3.2, and 3.3 28, we note that countries in the first group are
well integrated into global capital markets and maintain few
restrictions on international capital flows (indeed only slightly more on
average than the largest industrial countries). On the other hand, the
indicators for other AMF countries are similar, on average, to those of
developing countries as a group. These countries run a substantial
current account deficit, rely on attracting important inflows of foreign
direct investment, have a comparable openness to trade, and maintain
very similar numbers and types of restrictions on international current
and capital transactions. But they are less engaged in trade and make
greater use of exchange and capital controls than two of the most
dynamic regions, i.e., Latin America and the newly industrialized
countries of Asia. Among the second group (non-oil exporting AMF
countries), it is important to note that capital account transactions are
fairly liberalized in Jordan, Lebanon and Egypt. The three countries
register low (KCI) index values similar to the ones found in highly
liberalized oil-exporting countries. As capital is allowed greater
mobility, the capacity of these countries to use monetary and exchange
policies to achieve separate macroeconomic targets will be
increasingly constrained.
A great deal of market opening remains to be done, both with respect
to trade and capital flows, but to be successful and avoid endangering
macroeconomic and financial stability, the liberalization of capital
flows needs to be dealt with carefully. We return to this point when we
28
Tables are provided by K. Habermeier (2000).
28
discuss the recommendations pertaining to the issue of liberalizing
capital transactions in the group of Arab economies not yet integrated
in the global financial system.
29
Table 3.1. Indicators of Economic Integration
AMF
Countries
1
High Income
Oil Exporting
AMF
Countries
Other AMF
Countries
1
Major
Industrial
Countries
Developing
Countries
Newly
Industrialized
Asia
Mainland
Latin
American
Countries
(In percent of GDP, average 1995-99)
Current account balance
Foreign direct investment (net)
Portfolio outflows
Portfolio inflows
2
Openness
-0.8
1.0
0.0
0.1
75.3
1.2
0.3
-0.1
0.0
102.1
-2.5
1.5
0.0
0.1
54.0
0.31
0.23
0.40
0.44
0.37
-0.2
-0.5
-2.1
3.1
33.5
-1.4
2.0
-0.2
0.9
46.5
2.9
0.0
-1.1
0.7
132.9
-3.1
2.2
0.0
1.4
31.1
0.13
(Indices, normalized from 0 to 1)
0.38
0.08
0.37
0.16
0.21
0.06
0.19
0.30
0.13
0.29
0.48
0.50
0.47
0.06
0.27
0.26
0.27
0.13
0.29
0.30
0.27
3
Exchange and capital controls
Controls on current payments
and transfers
Capital controls
Capital controls, inflows
Capital controls, outflows
0.07
0.09
0.12
0.07
0.27
0.48
0.47
0.48
Source: IMF World Economic Outlook, IMF Annual Report Exchange Arrangements and Exchange Restrictions .
Data not available for Iraq and Palestine .
2
Exports plus imports of goods and services .
3
A value of 0 indicates the complete absence of controls; a value of 1 indicats the persence of controls on every category of transaction .
1
30
Table 3.2 Measures of Exchange and Capital Controls
in Non-High Income AMF Countries
AREAER
Indices of Controls
country
name
KCI-
KCI-
ECI
CCI
KCI
Inflows
Outflows
Algeria
0.45
0.38
0.53
0.5
0.59
Comoros
0.51
0.38
0.63
0.65
0.6
Djibouti
0.17
0.18
0.15
0.17
0.16
Egypt
0.18
0.12
0.25
0.38
0.17
Iraq
0.44
0.42
0.47
0.51
0.42
Jordan
0.09
0.06
0.12
0.24
0.05
Lebanon
0.11
0.04
0.18
0.23
0.17
Libya
0.59
0.46
0.72
0.7
0.7
Mauritania
0.51
0.38
0.63
0.59
0.69
Morocco
0.42
0.28
0.57
0.51
0.66
Somalia
0.56
0.45
0.68
0.59
0.71
Sudan
0.5
0.33
0.68
0.65
0.67
Syria
0.62
0.54
0.7
0.73
0.66
Tunisia
0.53
0.26
0.8
0.87
0.81
Yemen
0.09
0.12
0.06
0.13
0.01
Group average
0.38
0.29
0.48
0.50
0.47
31
Table 3.3 Measures of Exchange and Capital Controls
in High-Income Oil-Exporting AMF Countries
Indices of Control
AREAER country name
KCI-
KCI-
ECI
CCI
KCI
Inflows
Outflows
Bahrain
0.11
0.04
0.18
0.3
0.15
Kuwait
0.15
0.06
0.24
0.35
0.18
Oman
0.13
0.07
0.18
0.3
0.11
Qatar
0.08
0.06
0.09
0.17
0.04
Saudi
0.2
0.08
0.32
0.4
0.27
UAE
0.08
0.03
0.13
0.26
0.05
Group average
0.13
0.06
0.19
0.30
0.13
(CCI) denotes indices of control on current payments and transfers;
(KCI) denotees indices of capital controls; (ECI) denotes indices of
exchange and capital controls.
Arab financial systems: a brief evaluation
Given their often high degree of expertise and embracement of new
technology, Arab financial systems are not considered strong by the
international rating agencies. Eleven banking systems of AMF
members rated by Moody’s are not ranked in the top third in average
financial strength. These assessments reflect many different concerns
which vary country by country, but the most prevalent are poor credit
risk management practices, excessive credit concentration (often
reflecting undiversified economies), limited disclosure, inadequate
32
accounting, corporate governance, and limited liquidity, including in
the interbank market29.
As mentioned previously, sound financial systems form an integral part
of the “integrated approach” adopted by the IMF when advising on
reforms of exchange systems30. Adoption of international standards,
improvements in disclosure and transparency, and efforts to strengthen
financial systems are among the main issues discussed in fora around
the world concerning the new financial architecture. Their adoption
should increase both the integration of Arab financial and economic
systems with those in the rest of the world and at the same time make
them more resilient and stable. The details will differ substantially
from country to country. In the oil exporting countries of the Gulf,
greater transparency and improvements in financial sector governance
may stimulate foreign and direct investment, and by diversifying the
economy reduce the excessive reliance on oil exports. In many of the
poorer Arab countries, the financial and policy-making infrastructure is
still less developed. A consistent application of standards, be it in
monetary policy-making, prudential regulation and supervision, data
dissemination, or fiscal practices, will help to attract foreign
29
30
M. Kara (2000) “… to provide needed momentum for reforming Arab financial
systems, the AMF has responded by supplementing its traditional balance of
payments financing facilities with a new facility to assist its member countries in the
reform and modernization of their financial systems. The consensus is that
deepening, diversifying, as well as, strengthening one’s financial system is an
essential prerequisite to the achievement of high and sustained growth rates…”
The “integrated approach” emphasizes among other things the linkages between
liberalization and the need for sound financial markets and institutions, the
implementation of market-based monetary control, the adoption of appropriate
macroeconomic and exchange rate policies, and the development of prudential
safeguards to address specific risks involved in capital flows.
33
investment, put domestic saving to more productive uses, and boost
economic growth, while at the same time making economies and
financial systems more sturdy in the face of changes in world
economic conditions and market sentiment31.
Recent developments of exchange rates and policies in Arab
countries
Exchange rates in Arab countries experienced sharp fluctuations in
year 2000. The external value of ten Arab currencies declined against
the U.S. dollar. The extent of this effect was more prominent for
currencies related to the euro in light of the recent decline of the euro
against the dollar, which averaged about 14% during the year.
Accordingly, the decline of the exchange rates of the Tunisian dinar,
the Mauritanian ouguiya, and the Algerian dinar32 against the dollar
was 15.6%, 14%, and 13% respectively. In contrast, currencies of the
gulf countries, the Jordanian dinar and the Djibouti franc (countries
pegging to the U.S. dollar) appreciated against other major
currencies33.
31
32
33
This is based on a brief assessment of the situation provided by K. Habermeier
(2000).
During 1998 and early 1999, in the face of declining reserves, the authorities let the
dinar depreciate (by 18% vis-à-vis the U.S. dollar); the dinar stabilized in the latter
part of 1999 as hydrocarbon prices started recovering before depreciating again in
year 2000.
Joint Arab Economic Report (2001), Appendix (10/11)—Arab Monetary Fund.
“Exchange Rates: Domestic Currency Per U.S. Dollar (period average)”. Reproduced
in Table A5 in appendix A.
34
On the other hand, the Lebanese pound, the Egyptian pound and the
Moroccan dirham were among the Arab currencies that faced more
pressures than others. This has required the monetary authorities to
take necessary measures in an effort to reduce the excessive volatility
of the currency in the exchange market and its influence on the
performance of the local economy.
During year 2000, Lebanon adopted a policy of fixing its exchange rate
within a narrow band fluctuating between LP1501 and LP1514 against
the U.S. dollar. This policy is aimed at boosting the confidence in an
economy suffering from a declining growth, a huge debt buildup and
recently a re-surge in dollarization of the financial economy. The
central bank’s intervention in the foreign exchange market helped
stabilize the value of the pound albeit at the expense of drawing down
the gross level of foreign currency reserves from US$7.77 billion in
1999 to US$5.94 billion in 2000 to US$5.1 in June 200134. The ability
of maintaining the exchange rate within a narrow corridor hinges on
the success of the reforms undertaken lately which aim at spurring
growth, rationing government expenditures and speeding up the
privatization programs all in an effort to enhance the financial position
of the government and dissipating any crowding out effect exercised
by the public sector in the exchange market.
34
Joint Arab Economic Report (2001), Appendix (10/4)—Arab Monetary Fund.
“Official International Reserves of Arab Countries”. Reproduced in Table A6 in
appendix A.
--More recently, the drawdown of reserves in Lebanon has been more serious. As of
September 15, 2001, the gross figure stood at 3.868 billion dollars compared to
6.687 in September of 2000. The decline in net international reserves has been
steeper, reflecting the trend shift from local currency to dollar deposits (only US$1.2
billion at the end of June 2001).
35
Similarly, the Egyptian pound faced significant pressures in 2000.
Dating back to 1991, the objective of a (de facto) fixed exchange rate
policy against the dollar was protecting those who transact on the
international markets from excessive fluctuations in the foreign
exchange market and bolstering international investors’ confidence in
the local economy. The stability of the pound up to 1997 led to a surge
of financial flows and to an increase in official reserves of the central
bank.
In the late 1990s, macroeconomic performance weakened as a result of
a combination of policy and external factors. Among the external
factors, the pound continued to appreciate as a result of the
strengthening of the U.S. dollar to which it remained pegged. This
along with a temporary tourism slowdown and a tightening of global
financing after the Asian crisis resulted in sizable official reserve
losses. In 1997, the series of shocks hitting the economy led the central
bank to intervene in meeting the markets’ needs of foreign exchange in
support of its fixed exchange rate policy. The loss of reserves was
estimated at about US$5.6 billion between 1997 and 2000 (from a peak
of US$18.7 billion in 1997 down to US$13.1 billion in 2000—albeit,
still a comfortable position by all means). The monetary tightening in
1999-2000 has reduced pressures on the exchange rate and helped
stabilize official reserves toward end-2000. At end-June 2001, net
official reserves amounted to US$14.2 billion.
During 2000, seeking to strengthen external position, the authorities
departed from the de facto peg to the U.S. dollar adopted in early 1991.
The shortage of liquidity of foreign exchange in the markets reached
36
its peak in 2000, leading to substantial deterioration in its current
account deficit. In light of these developments, the monetary
authorities allowed a devaluation (against the dollar) by the foreign
exchange dealers reaching around 14% in 2000 with a high and low for
the external value of 3.42 and 3.89 respectively. The devaluation along
with other positive factors (oil prices increases and tourism sector
pickup) ameliorated the current account situation in 2000. Following
an initial depreciation, an adjustable currency band was adopted
against the U.S. dollar in January 2001. This band was subsequently
further depreciated and widened in mid-2001, resulting in a cumulative
depreciation of about 25% relative to the U.S. dollar.
As for Morocco, the source of pressures that faced the Moroccan
dirham in the foreign exchange market in year 2000 came primarily
from textile, clothes and agriculture products’ exporters and from
tourist companies. Despite the strong external position, the external
competitiveness of these sectors has been likely affected during the
1990s by an appreciation of the real effective exchange rate (REER).
This, along with other important factors, may have contributed to some
losses in export market shares when compared to more export-oriented
developing countries. The substantial rise in capital formation over the
last couple of years should reinforce export capacity, and tourism
receipts and related activities have already rebounded over the last two
years. Even though the REER appreciation has slowed down
considerably with declining inflation, tariff dismantling under the
Association Agreement with the European Union (AAEUs), combined
with the phasing out of textile quotas under the WTO, will put added
competitive pressures on the economy.
37
To date the monetary authorities have not succumbed to the demands
of these export sectors to devalue the currency, which proclaims such a
move would boost the competitiveness of their products and services in
the international markets. The authorities fear the negative
repercussions of a weaker currency on the economy stemming from a
further increase of the oil import bill, an increase in the servicing costs
of the external debt and importing of external inflation. The potential
role of a more flexible exchange rate policy in strengthening
competitiveness is assessed later.
For Sudan, the feeling at the IMF is that no major pressure on the
exchange rate is evident, despite the virtual stability in the rate in 2000.
38
III. Assessment
Economic performance of Arab countries under alternative
exchange rate regimes
Inflation and growth
We briefly review the extent to which a country’s economic
performance and the way in which monetary and fiscal policies affect
inflation and growth depend on the exchange rate regime.
Before the case of Arab countries is dealt with, we note in general that
for countries around the world, inflation has been lower and less
volatile in the past in countries with pegged exchange rates in
comparison
to
countries
with
more
flexible
exchange
rate
arrangements. Though such a difference has narrowed substantially in
the 1990s35. On the other hand, there does not appear to be a clear
relationship between exchange rate regime and output growth.
In confirmation of the general view that alternative exchange rate
regimes on their own do not necessarily lead to better or worse
35
Over the past several years, inflation in the developing world has come down
sharply, even as the number of countries adopting more flexible exchange rate
arrangements has steadily increased. There is almost a convergence in median
inflation rates in countries of different exchange rate regimes. This is probably a
reflection of the fact that the same factor that has underlined the need for greater
exchange rate flexibility, namely, the increased international integration of financial
markets, has also served to discipline countries’ macroeconomic policies.
39
inflation rates36, the performance (in terms of inflation) of a group of
Latin American countries selected arbitrarily is summarized in the
following table.
Year 2000
Regime
Inflation
Peg (CBA)
-0.7
Bolivia
Peg (crawling)
3.4
Brazil
Float
5.3
Chile
Float
4.5
Peg (dollarization)
91
Float
3.7
Peg (with band)
5
Argentina
Ecuador
Peru
Uruguay
In this respect, we postulate right from the beginning that economic
growth can be satisfactorily high, and inflation desirably low, under
either exchange rate arrangement provided that appropriate policies
and other conditions for good economic performance are in place.
As for Arab economies, most of them experienced a general
deceleration in inflation as a result of prudent monetary and fiscal
policies. Generally tightened demand management policies, and in
some countries exchange rate corrections, helped to reduce external
current account deficits. Despite this deceleration in inflation, it seems
that the group of Arab countries adopting floating exchange rates
registered higher inflation rates than the pegged group. In year 2000,
36
There are cases in which exchange rate stabilization policies resulted in lowering
inflation, but unless accompanied by timely “exit” strategies, such policies may have
adverse consequences on the economy.
40
Sudan and Yemen registered the highest inflation rates in the region
(10% and 9%, respectively), while Tunisia, Algeria, Egypt, Mauritania,
all belonging to the managed float (MF) group, recorded higher
inflation on average than the fixed and pegged regimes group—the
average inflation for the (MF) group is 2.6% compared to an average
of 0.4% inflation rate in AGCC countries belonging to the peg group.
In this regard, it is interesting to note a correlation between the high
level of international integration of financial markets (low index value
of exchange and capital controls) and low inflation, which applies for
most of the countries just mentioned. It would appear that increasing
the international integration of financial markets (say in Algeria,
Tunisia, Mauritania, and Sudan) could add a further disciplining
element to the countries’ macroeconomic policies.
Despite the general positive picture of successful demand management
policies, low inflation and fiscal retrenchment, growth of real GDP
remained generally weak while population continued to grow briskly
in the region. The slow pace of improvements in production efficiency
may have contributed to the modest inflow of foreign direct investment
and kept growth largely import substituting rather than outward
oriented. While this paper is not about the causes of the slow growth in
the region, it is obvious that a structural reform strategy to improve
resource allocation and create institutional conditions suitable for
accelerated growth while maintaining internal and external stability is
desperately needed. As will be seen later, exchange rate flexibility is
advocated as part of this strategy in a number of cases.
41
Table 4. Annual Rates of Change in the Consumer Price Index
Arab Countries (1989 -2000 )
(in percent )
COUNTRY
Jordan
United Arab Emirates
Bahrain
Tunisia
Algeria
Saudi Arabia
Sudan
Syria
Somalia
Iraq
Oman
Qatar
Kuwait
Lebanon
Libya
Egypt
Morocco
Mauritania
Yemen
1989
1990
1991
1992
1993
1994
25.7
3.3
1.5
7.8
9.3
1.0
70.0
11.4
101 .8
6.2
1.4
3.3
3.3
69.9
...
21.2
3.1
12.9
20.3
16.1
0.6
0.9
6.5
16.7
2.0
64.7
19.3
200 .3
10.9
-0.4
3.0
9.9
70.1
...
16.8
7.0
6.6
34.0
8.2
5.5
0.8
8.2
25.9
4.9
125 .0
9.0
...
328 .6
4.6
4.4
9.1
60.0
...
19.8
8.0
5.6
36.0
4.0
6.8
-0.2
5.8
31.7
0.2
117 .5
11.0
...
68.1
1.0
3.1
-0.5
105 .0
...
13.6
5.7
10.1
29.4
4.7
5.1
2.5
3.9
20.5
0.8
101 .5
13.2
...
...
1.2
-0.8
0.4
8.8
...
11.1
5.2
9.4
38.1
3.6
4.2
0.9
4.8
29.0
0.6
115 .2
15.3
...
...
-0.7
1.3
2.5
10.0
...
9.0
5.2
4.2
49.4
Source : Economic Indicators, Table
5. Arab Monetary Fund (2001 )
1995
2.3
4.8
2.7
6.3
29.8
4.9
68.4
7.6
...
...
-1.3
3.0
2.7
10.3
...
9.3
6.1
6.6
54.5
1996
6.5
2.6
-0.2
3.7
18.7
0.9
132 .8
8.8
...
...
0.3
2.5
3.6
8.9
...
7.2
3.0
4.7
30.8
1997
3.0
2.0
1.0
3.7
5.7
-0.4
46.6
2.2
...
...
0.6
4.9
0.7
7.8
...
4.6
1.0
4.6
-3.6
1998
3.1
3.5
-0.4
3.0
5.0
-0.2
17.1
-0.5
...
...
-0.6
2.9
0.2
4.0
...
3.8
2.7
8.0
5.5
1999
0.6
2.0
1.3
2.7
2.6
-1.3
16.0
-2.1
...
...
0.4
2.2
3.0
1.0
...
3.1
0.7
4.1
-1.2
2000
0.7
1.3
2.0
4.1
0.3
-0.7
10.0
-0.6
...
...
-0.8
-1.0
1.7
0.0
...
2.1
0.6
3.2
9.0
42
Table 5. Annual Growth Rates of Gross Domestic Product
Arab Countries (1995 -2000 )
(%)
(national data in local currency ) **
COUNTRY
Jordan
United Arab Emirates
Bahrain
Tunisia
Algeria
Djibouti
Saudi Arabia
Sudan
Syria
Iraq
Oman
Qatar
Kuwait
Lebanon
Libya
Egypt
Morocco
Mauritania
Yemen
Arab Countries
1995 -2000 *
1995
3.0
6.4
5.2
6.7
4.0
3.9
5.7
2.4
3.4
3.8
0.1
-3.6
1.7
0.5
5.7
4.4
3.6
5.8
…
…
3.1
4.8
10.4
2.9
1.4
1.2
2.0
6.5
1.6
-1.6
5.7
4.7
3.1
-6.6
4.4
4.5
5.5
10.9
3.5
…
* Average annual growth rate over the period
.
**National data provided by officials in Arab Countries
Source :Joint Arab Economic Report
1996
2.1
6.1
4.1
7.1
3.8
-3.7
1.4
4.0
7.3
…
2.9
4.8
1.2
4.0
1.2
5.0
12.2
4.7
5.9
4.0
.
(2001 ), Appendix (7/2).
1997
3.1
6.7
3.1
5.4
1.1
0.7
2.0
6.7
2.5
…
6.2
24.0
2.3
4.0
1.3
5.3
-2.2
4.8
8.1
3.4
1998
2.9
4.1
4.8
4.8
5.1
0.8
1.7
5.0
7.6
…
2.7
12.3
2.0
3.0
-3.0
5.7
6.8
3.5
4.9
3.7
1999
3.1
3.8
2.9
6.2
3.3
1.3
-0.8
6.0
-1.8
…
-1.0
7.6
-2.4
-1.0
2.0
6.1
-0.7
4.1
3.7
1.8
2000
3.9
5.2
5.2
5.0
3.8
1.5
4.1
6.7
2.5
…
4.6
4.3
4.1
0.0
6.5
6.5
0.3
5.0
5.1
4.4
43
Measure of competitiveness37
There has been an increased recognition in Arab countries of the role
played by external policies, particularly exchange rate policies, in
achieving and maintaining competitiveness, and thus balance of
payments viability, which is critical for sustained growth.
The real exchange rate (RER) is deemed to be a good proxy for a
country’s degree of competitiveness in international markets.
According to Edwards (1988), it is defined as the relative price of
tradable goods with respect to the price of nontradable goods. A
decline in the RER represents a real exchange appreciation or a rise in
the domestic cost of producing tradable goods. An increase,
conversely, reflects real exchange depreciation or an improvement in
the country’s international competitiveness38.
Few papers on the effects of real exchange rate misalignment
(RERM)39 on the collective economic growth of Arab countries have
been written. RERM describes a situation in which a country’s actual
(RER) deviates from its long run, sustainable, equilibrium-level.
Misalignment could refer to either an undervalued or overvalued
37
38
39
Reference: (1) Domaç and Shabsigh and (2) Nashashibi, Brown and Fedelino:
Chapters 8 and 10, respectively, in I. Zubair, editor (2001).
Below, we use the IMF methodology in defining a real effective exchange rate based
on an indirect quote for the exchange rate. See Aghevli, Khan and Montiel (1991).
There is generally a lack of consensus on what constitutes an appropriate indicator of
misalignment and the methodology for producing it.
44
exchange rate—in the latter case the exchange rate is more appreciated
than its equilibrium level. Correction of misalignment generally entails
both demand management policies as well as real exchange rate
adjustments. In summary, misalignment can lead to a reduction in
economic efficiency, a misallocation of resources, and capital flight40.
Evidence from Latin America, Asian, and African countries supports
the view that the link between the RER behavior and economic
performance is strong. It is argued that, although unstable RERs
undermined export growth in Latin America, their stability was central
in promoting East Asian expansion. Conversely, many African
countries experienced sustained RERM, which in turn obstructed the
development of agriculture and reduced the domestic food supply.
Among the rare studies of Arab countries’ exchange rate policies and
their effects on economic performance, Domaç and Shabsigh study the
40
Misalignments adversely affect economic growth in three different ways. First, they
could undermine external competitiveness by overpricing exports. This would result
in deterioration in the external balance and a depletion of foreign exchange reserves.
This in turn may ultimately lead to a sharp devaluation in the wake of an external
balance of payments crisis, with the associated adverse effects on domestic prices
and production. Second, they could cause a misallocation of resources by distorting
the prices of domestic goods relative to each other and to international prices. This
would adversely affect domestic investment, causing losses in domestic production
through reduced efficiency. Third, they could adversely affect domestic financial
markets, by increasing uncertainty in these markets and by encouraging speculation
against the domestic currency. If the overvaluation is sustained, many industries and
banks may fail due to speculation. In the latter case, the government may have to
bear heavy costs to bail out the financial system … Domaç and Shabsingh (2001).
--See also Cottani, Cavallo and Khan (1990) on the links between RER and economic
growth.
45
effects of exchange rate policies on growth in four Arab countries
(Egypt, Jordan, Morocco and Tunisia) for the period 1970-1996. The
empirical results confirm that misalignments stemming from exchange
rate policies in these countries had adverse effects on their economic
growth during the period 1970-1990. The authors note that the
liberalization and economic reform policies initiated by these countries
in the late 1980s and 1990s have resulted in major realignments of
their real exchange rates, which—if pursued in a sustained fashion—
could enhance their growth prospects.
Nashashibi, Brown and Fedelino (2001) on the other hand assessed,
among other things, how Arab countries as a group has fared in
competitiveness41. To this end, they analyzed development in real
effective exchange rates (REER) as an indicator of competitiveness. To
isolate the effect of oil on export and output, Arab countries were
divided in two groups, oil-exporting countries (comprising Algeria,
Libya and GCC countries) and non-oil-exporting countries (Djibouti,
the Arab Republic of Egypt, Jordan, Lebanon, Mauritania, Morocco,
Sudan, the Syrian Arab Republic, Tunisia, and the Republic of
Yemen).
For oil-producing countries, whose first and foremost export is oil, the
real exchange rate is not necessarily an indication of competitiveness,
41
Nashashibi, Brown and Fedelino (2001) provided the relevant REER series. The
following paragraphs draw heavily from the thorough analysis of the series’ behavior
in their paper.
46
because oil prices are determined in the world market and costs of
production are not a determinant of export performance. Nevertheless,
for these countries the real exchange rate is still a relevant indicator of
the competitiveness for non-oil exports as well as of the tradable sector
as a whole; this is important for the oil-exporting countries with
relatively large populations (e.g., Algeria and Saudi Arabia) where
there is a need to create employment opportunities for the rapidly
growing labor force, or for those oil-exporting countries where there is
substantial potential for non-oil activities (Bahrain, Oman, Qatar, and
the UAE particularly in the service sector).
REER is defined according to the standard IMF methodology as
follows42:
REER
=
e
n
P
Σ w i it d
e io P
i=1
fi
eit : units of foreign currency per unit of domestic currency
wi : bilateral (trade) weights, where the subscript (i) denotes the
ith partner
n : (trading) partners
Pfi : the level of foreign prices in the trading partner country i
42
Under the assumption that all traded goods are homogeneous and that international
trade equalizes their prices across countries, the REER provides a measure of the
evolution of nontradable prices in various countries. With an indirect quote definition
of the exchange rate, an increase (numerical) in the REER indicates appreciation and,
other things equal, a loss of competitiveness.
47
(0)
: base year
Pd : level of consumer prices in the home country
In analyzing the recent REER trends, the authors noted that the REER
depreciation of the 1980s reversed into appreciation in the 1990s for
the region as a whole. REER averages for the three main country
groupings in the region (GCC, Mashreq, and Maghreb43) showed
depreciation in the latter half of the 1980s reversing into appreciation
in the early 1990s (Figures 3 and 4). Regression analysis also supports
the evidence of a turnaround in the trend around 1992 toward
appreciation.
What factors contributed to the reversal of this trend? For the GCC
countries, whose currencies are pegged to the U.S. dollar (or to baskets
in which the dollar is a significant component), the main factor was the
appreciation of the dollar in the 1990s. A similar factor may have been
at play for several of the Mashreq economies, and for Morocco, all of
which adopted fixed exchange rate regimes in the early 1990s.
Moreover, although these countries have generally succeeded in
implementing tight demand management policies and have achieved
substantial fiscal retrenchment to contain the rise in nontradable prices,
during the period 1992-1998 some inflation differentials remained
relative to trading partners, resulting in further real appreciation. In
43
GCC countries include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United
Arab Emirates; the Mashreq economies include Egypt, Jordan, Lebanon and Syria;
and the Maghreb economies include Algeria, Morocco and Tunisia.
48
contrast to the fixed exchange rate regimes adopted by the countries
mentioned above, Algeria, Tunisia, and Yemen adopted more flexible
exchange rate policies. Tunisia targeted a stable real effective
exchange rate after 1992, depreciating its nominal exchange rate by 4
percent annually relative to the dollar between 1992 and 1998. Algeria
also adjusted its rate of exchange to ensure that the REER would not
appreciate on a sustained basis. Consequently, the post-1992 REER
appreciation for both countries was much less pronounced than for the
first group of countries.
.
49
Figure 3. Annual Changes in Real Effective Exchange Rates and Terms of Trade in Arab Countries
(in percent)
20
Arab countries
15
Terms of trade
10
REER
5
0
-5
-10
-15
-20
1981
1983
1985
1987
1989
1991
1993
1995
1997
1995
1997
20
Gulf Cooperation Council countries
15
Terms of trade
US REER
10
5
0
-5
REER
-10
-15
-20
1981
1983
1985
1987
1989
1991
1993
Source: IMF, Information Notice System and World Economic Outlook. Note: Annual
changes in country’s REER are weighted by the country’s share of total export volume for
the whole sample in the same year.
50
This appreciation appears to have contributed to the slowing of export
volume growth in the 1990s, particularly in the last three years of the
sample. Figure 5 provides some preliminary evidence on the negative
relationship between the changes in REERs and export volumes
(excluding oil, since oil exports are unlikely to be affected by
movements in a country’s REER) for the sample period. Episodes of
real appreciation in REERs dampened the growth of non-oil exports
and the potential for diversification. Tunisia’s managed exchange rate
may have helped to promote its export performance, which improved
in the 1990s, in contrast to the declines experienced by Morocco,
Egypt and Jordan. For some non-oil exporting countries with fixed
exchange rates, such as Egypt and Jordan, the decline in export volume
growth in the last three years was quite sharp.
51
Figure 4. Annual Changes in Real Effective Exchange Rates and Terms of Trade in Arab Countries
(in percent)
20
Maghreb economies
15
10
Terms of trade
5
0
-5
-10
-15
REER
-20
1981
1983
1985
1987
1989
1991
1993
1995
1997
1995
1997
30
Mashreq economies
Terms of trade
20
REER
10
0
-10
-20
-30
1981
1983
1985
1987
1989
1991
1993
Sources: IMF, information Notice System and World Economic Outlook. Note:
Annual changes in a country’s REER are weighted by the country’s share of total
export volume for the whole sample in the same year.
52
Figure 5. Export Indicators for Arab Countries
25
20
Export Volume
15
10
5
0
-5
REER
-10
-15
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
1994
1996
1998
700
600
Tunisia
500
400
Jordan
300
200
Morocco
100
Egypt
0
1980
1982
1984
1986
1988
1990
1992
Sources: IMF, Information Notice System and World Economic Outlook.
1 For Algeria and the Gulf Cooperation Council countries, includes only non-oil exports.
For other countries, includes total exports.
53
Although it is perhaps too early to see strong signs of the potential
effects of such developments on real GDP growth, some countries
nevertheless experienced a noticeable decline in real GDP growth in
the last three years of the sample period.
Some theoretical hypotheses explaining the choice of exchange rate
regimes
Are two sizes only fit for all Arab economies?
The evidence presented in section II predicates that countries around
the world are moving away from the center of the distribution of
exchange rate arrangements. Hence, it is useful to ask whether the two
sizes deemed to be the only viable choices according to the bi-polar
view is fit for Arab countries (taking into consideration the importance
of the exchange rate for mid-size and smaller open economies). For
various reasons, such economies have opted not to choose a hard peg
regime (with the exception of Djibouti44). On the other hand, in light of
the absence of well developed monetary, financial and policy-making
institutions in the region, a smoothly functioning pure floating regime
cannot be realistically supported. For the moment, intermediate
regimes continue to be in favor—mathematically, the solution to the
tradeoff between internal monetary stability and constancy of the
exchange rate is likely to be an interior one.
44
The desirability of creating a currency board in the Palestine Authority—among
other alternative monetary regimes—is reviewed later.
54
As classified elsewhere, most Arab economies45 are non-emerging
market developing economies. In this section, a distinction is drawn
between (1) oil-exporting economies characterized as being well
integrated into global capital markets (the group of GCC members), (2)
non-oil
exporting,
highly-integrated
countries
(Egypt,
Jordan,
Lebanon) and, (3) non-oil exporting countries, with high exchange and
capital controls.
When assessed against the bi-polar hypothesis (built on the premises of
increased capital mobility), the conclusion is that because of the
limited involvement of non-emerging market developing countries
with modern global financial markets, some form of exchange rate peg
or band or highly managed float is generally more viable and more
appropriate for them than for most of the emerging market countries46.
While this conclusion may well be true in general, it is contrasted
using an example drawn from the globally integrated AGCC countries.
The viability of their (pegged) regimes is more so attributed to the fact
that the currencies are backed by hefty foreign exchange reserves and a
war chest of billions in U.S. dollars of liquid securities invested
overseas. With the loss of the monetary independence as a stabilization
tool (dictated by the “impossible trinity” argument) readily accepted by
the monetary authorities, an alternative compensating adjustment
mechanism, based on the stabilization role of the fiscal policy (mainly
45
46
Recall that Egypt, Jordan, Morocco and Qatar are regarded as “emerging markets”
economies.
Mussa et al (2000).
55
through a fiscal transfer system not afforded elsewhere in the region) is
put in place.
What about the validity of the arguments proposed by the fear of
floating hypothesis47 in explaining the pegged exchange rate regimes in
the region? High dollarization in financial systems on the asset side
(foreign denominated assets held) and/or high unhedged foreign
currency liabilities can both increase the likelihood of fixing the
exchange rate48. A fixed arrangement as such is likely to protect the
economy from the effects of potentially excessive exchange rate and
money market volatility. This fear of floating hypothesis argument
rightly applies in the case of numerous Arab countries who officially
allow their exchange rate to float but don’t in actual practice, rendering
in this case the demise of the fixed exchange rates a fallacy.
The general trend dictates that as the ability in hedging exchange rate
risk exposure is enhanced, and as countries not yet integrated in the
global financial system increasingly become so49, it is more likely that
47
48
49
Calvo and Reinhart (2000).
Lebanon, Yemen, Jordan and Egypt are among the more highly dollarized systems in
the Arab region. This is illustrated in Table B1 in Appendix B.
Countries would want to open up their capital account as a natural step in their
development progress. The evidence that the more developed economies in fact all
have open capital accounts backs this claim. On the positive side, less restrictive
capital controls and higher international capital flows can increase investment
possibilities, create technology spillovers, and deepen domestic capital markets. The
possibility of sudden capital flows reversals can create instability in the economy.
However, strong and internally consistent domestic macroeconomic and financial
policies, and sufficiently developed financial systems to cope with large capital
flows, together work to reduce the magnitude of that risk.
56
we will observe greater exchange rate flexibility. In the meantime,
until such features evolve and become well established, the order of the
day for most Arab economies following a pegged system is to continue
with their policies. The say “if it ain’t broke, don’t fix it” rightly
applies here. Undoubtedly, there are important qualifying caveats that
need to be respected on a country-by-country basis in order to take into
account the wide differences in the levels of economic and financial
development among Arab countries.
Prior to assessing the use of nominal anchors in conducting monetary
policies in Arab countries, Box 3 highlights concepts in explaining the
optimal choice of exchange rate regimes. Among the more important
ones, the impossible trinity argument, the internal consistency of
monetary and exchange rate policy and operations, the effective ways
to liberalize the capital account and intervention in the foreign
exchange markets are discussed in details.
57
Box 3. Monetary and Exchange Rate Policy and Operations, and Issues
in Capital Account Liberalization and Foreign Exchange Intervention
The impossible trinity
Secular movements in the scope for international lending and borrowing is
understood in terms of a fundamental macroeconomic policy trilemma that
all national policymakers face: the chosen macroeconomic policy regime can
include at most two elements of the “impossible trinity” of (i) full freedom of
cross-border capital movements, (ii) a fixed exchange rate, and (iii) an
independent monetary policy oriented toward domestic objectives.
If capital movements are prohibited (element (i) is ruled out), a country on a
fixed exchange rate can break ranks with foreign interest rates and thereby
run an independent monetary policy. Similarly, a floating exchange rate
(element (ii) is ruled out) reconciles freedom of international capital
movements with monetary-policy effectiveness (at least when some nominal
domestic prices are sticky). But monetary policy is powerless to achieve
domestic goals when the exchange rate is fixed and capital movements free
(element (iii) is ruled out), since intervention in support of the exchange
parity then entails capital flows that exactly offset any monetary-policy
action threatening to alter domestic interest rates.
Countries’ attempt simultaneously to hit exchange-rate targets and domestic
policy goals has, almost as a logical consequence, entailed exchange controls
or other harsh constraints on international transactions, not to mention the
related problems of policy credibility and international noncooperation
similarly inimical to foreign investment.
Reference: Obstfeld and Taylor (1996)
58
Box 3…continue
Internal consistency of monetary and exchange rate policy and operations
Internal consistency of the elements of monetary and exchange rate policies
is crucial in ensuring the achievement of the authorities’ ultimate objectives
of economic policy. The exact manner in which this consistency is
manifested in turn depends on the nature of the chosen arrangement and the
accompanying operating monetary framework.
The integration of financial markets globally has underscored the need for
consistency between exchange and monetary policies, as countries
deregulated their financial systems and liberalized their capital account50. In
such an environment, less than consistent policies complicates, and places
significant strains on, the implementation of monetary policy. Against this
backdrop, an underlying condition based on the principal of arbitrage
suggests that the ex-ante risk adjusted rates of return will be equalized across
all assets. The uncovered interest rate parity condition states that in a fixed
(pegged) or targeted (crawling) exchange rate regime, the central bank must
set the interest rate consistent with the foreign interest rate adjusted for
expected exchange rate depreciation. If it does not, capital flows will tend to
undermine monetary policy. As long as the exchange rate (or the targeted
rate) is credible, it represents an implicit guarantee for capital flows. The
covered interest rate parity condition (in the presence of a formal forward
exchange market) states that provided that domestic and foreign assets are
perfect substitutes, international mobility of capital will ensure equality of
rates of return across countries. Because the foreign interest rate and forward
exchange rate are determined externally, a country can only determine the
domestic interest rate or the spot exchange rate, but not both. With greater
freedom of capital movements, any attempt to set both interest rates and
exchange rates could give rise to incentives for significant short-term capital
50
The principal forces driving the growth of international trade and investment are (1)
the liberalization of financial transactions, including the deregulation of financial
markets, (2) the removal of controls on capital movements, (3) and the liberalization
of trade and exchange controls (technological and financial innovation has also
shaped the evolution of the international exchange and payments systems).
59
Box 3…continue
flows. In the presence of capital controls, however, some temporary
independence of monetary policy could be achieved51.
Liberalizing the capital account … the effective way
As a country develops it would want to open up its capital account52. This is
best done gradually, at a time when the exchange rate is not under pressure,
and, as the necessary infrastructure—in the form of strong and efficient
domestic financial institutions and markets, a market-based monetary policy,
an effective foreign exchange market, and the information base necessary for
the markets to operate efficiently—is put in place. Unless the country intends
to move to a hard peg, it would be desirable to begin allowing some
flexibility
51
52
Ariyoshi et al (2000) provide a detailed discussion of experiences with capital
controls. Based on internally consistent macroeconomic and structural policies,
China successfully maintained its pegged exchange rate through the Asian crisis with
the assistance of capital controls. In Malaysia (a relatively more open economy than
China) the idea behind the controls was that, insulated from speculative pressure,
interest rates can be cut without sending the currency through the floor, while the
government gives the economy a big fiscal stimulus. However, the slow progress
achieved to date in tackling the non-performing loans’ problem, as part of reforming
Malaysia’s banking system, remains a major obstacle in the economy. As for the
capital inflows controls, as in a Chilean encage markets-based style, the typical
instance occurs when a country is trying to reduce inflation using an exchange rate
anchor, and for anti-inflationary purposes needs interest rates higher than those
implied by the sum of the foreign interest rate and the expected rate of currency
depreciation. A tax on capital inflows can in principle help maintain a wedge
between the two interest rates. The effectiveness of such measures wears off if
applied over a long period of time.
The following is probably more appropriately directed to Arab countries liberalizing
their capital accounts at the same time holding modest reserves for defending
credibly a pegged regime. Those countries are also assumed to lack a substitutable
adjustment compensating mechanism to the stabilization role a flexible regime offers.
60
Box 3… continue
of exchange rates as the controls are gradually eased. Prudential controls that
have a similar effect to some capital controls would also be put in place as
direct controls are removed.
In most general cases, the policy response to capital inflows has involved
allowing more flexibility in exchange arrangements. Nevertheless, some
countries have subordinated monetary policies to the maintenance of
exchange rate pegs as part of their programs of stabilization and structural
reform, or in the context of regional integration initiatives. On the other hand,
there are countries that have adopted a strong nominal exchange rate anchor,
subordinating monetary policy to the maintenance of the anchor, and allowed
interest rates to adjust in response to capital movements. This has enabled
them to avoid capital flow reversals that would have been provoked by
uncertainty about the exchange rate. Because they cannot use exchange rate
policy to reduce short-term capital inflows, they have paid greater attention to
prudential standards53 to reduce the risks associated with potential reversals
in capital flows. Other countries have targeted the exchange rate (hence,
monetary policy) to maintain competitiveness and relied on fiscal
consolidation to achieve domestic stabilization and offset the effects of large
capital inflows. However, because fiscal policy is fairly inflexible in the short
term, the authorities have had to resort to other measures—capital controls,
in particular—to deal with volatile flows. Generally, such controls are
effective primarily as temporary measures … Fischer (2001).
53
Prudential regulations can, for example, limit the open foreign exchange positions of
banks, but it is harder to control corporate sector financing through such regulations,
and it is in any case probably unwise to rely to too great an extent on supervision to
prevent transactions that would otherwise be highly profitable … (Fischer 2001). I
must add that the heavy weight on regulation and supervision must give way to
greater emphasis on market discipline, where the rules are monitored and enforced by
the action of the financial markets. Financial engineering and cheap information
technology increase the ability of banks to escape regulation. Moreover, regulatory
sources cannot match those available to private sector.
61
Box 3…continue
It is also worth noting that high capital mobility alters the effectiveness of
different monetary instruments in achieving the objectives of monetary
policy. For example, instruments that impose a high cost or administrative
constraints on the banks may be circumvented more easily by
disintermediation through the capital account, and therefore become less
effective54.
Intervention in foreign exchange
Intervention strategy is outgrowth of broader policy choices. In light of the
importance of exchange rates, some countries intervene directly from time to
time in the foreign exchange markets to try to stabilize them55 over and above
the interest rate policies that also work to affect the exchange rate.
Decisions as to which two to choose from the impossible trinity have an
impact on the intervention regime of a country. Under a currency board
arrangement in Hong Kong, capital flows freely and interest rates are linked
to the U.S. monetary policy. The intervention is quite frequent—the
willingness to tolerate very high interest rates when HK$ is under pressure is
plausible given the strong banking systems in HK. New Zealand follows a
free float (no intervention has been conducted in the last 16 years), allows
capital flows and retains control over monetary policy. Another example,
Malaysia, followed a fixed rate supported by intervention and system of
capital controls (capital controls applied in 1998) while retaining control over
monetary policy.
While intervention is passive (can become more active at times when
currency is under pressure) under fixed or pegged regimes, it is rather active
(policymakers must make affirmative decision) under a floating rate regime.
54
55
The process of sequencing financial sector reforms is summarized in the book by
Johnston and Sundararajan (1999)—Chapter 2 deals specifically with the issue of
monetary control reform and the use of indirect monetary instruments.
The Fed in the U.S. intervenes to “counter disorderly market decisions”. Canada
practices “leaning against the wind” policy.
62
Box 3…continue
Intervention is used periodically when market is at extremes. So long as they
are not perceived as trying to defend a particular rate, such interventions can
be useful. Admittedly, this is one area in which central bankers follow more
or less a judgmental approach about market conditions when intervening.
A distinction is drawn between (1) unsterilized intervention (the norm in
fixed rate regimes) where the foreign exchange intervention is not offset by
other domestic open market actions56 and, (2) sterilized intervention (the
normal situation in floating rate regimes) where the foreign exchange
intervention is offset by activity in domestic reserves market57. Here foreign
exchange intervention is not allowed to dictate monetary policy stance; it
affects composition of central bank balance sheet—but not the size (example:
reduced foreign securities and increased domestic securities).
As far as Arab economies are concerned, it is important that large (one-sided)
interventions in the foreign exchange markets do not result in large real
appreciation in their currency, which may hamper the development of
diversified and competitive export sectors. Efforts to further develop the
interbank foreign exchange markets should be stepped up while reducing the
exchange transactions undertaken by central banks to encourage greater
participation by banks.
56
57
Example: The central bank buys domestic currency and reduces liquidity. This leads
to a rise in interest rates inducing investors to buy currency. This is the only kind of
intervention that can be systematically effective under fixed exchange rates.
Example: The central bank buys domestic currency and reduces liquidity; ceteris
paribus, interest rates rise. To offset drain from intervention, it buys domestic
government securities and pays with cash.
63
Monetary regimes and corresponding operating frameworks
In recent years a growing consensus has emerged for price stability as
the overriding, long-run goal of monetary policy. However, despite this
consensus, the following question still remains: how should monetary
policy be conducted to achieve the price stability goal?58 The monetary
policy frameworks in Arab countries (as shown in Table A3) are
revisited. While monetary arrangements employed to achieve the
objective of price stability differ, we discern from the Arab experience
a prevalent use of exchange rate anchors.
Different types of monetary and exchange operating frameworks may
address differently certain policy conflicts that may arise from a
significant
exogenous
shock
or
preexisting
macroeconomic
disequilibrium. The ultimate choice among alternative operating
frameworks depends on the preferences of the monetary authority
regarding which type of trade-off they wish to accommodate, the
specific features of the economy (openness, nature of the shocks
affecting the economy), the stage of development of the financial
markets, the technical capacity of the central bank59, the fragility of the
banking sector, the magnitude of fiscal deficit and public debt and the
nature of the transmission mechanism through which the effects of the
central bank’s actions are transmitted—a tall order of things to
consider.
58
59
To shed light on this question, Mishkin (1999) examines the experience with
different monetary policy regimes currently in use.
Where such capacity lacks, more rule-based frameworks such exchange rate pegs or
mechanical money growth targets are favored.
64
Exchange rate anchors in Arab economies: advantages and words of
caution
With open capital markets, an exchange-rate target results in the loss
of monetary policy independence since the targeting country loses the
ability to use monetary policy to respond to domestic shocks that are
independent of those hitting the anchor country. An exchange-rate
target means that shocks to the anchor country are directly transmitted
to the targeting country because changes in interest rates in the anchor
country lead to a corresponding change in interest rates in the targeting
country (irrespective of the conditions in the targeting country in terms
of growth and unemployment)—this is generally true for a large
number of Arab countries pegging to the U.S. anchor country.
Under an exchange-rate target regime, it is often argued that central
banks are more susceptible to pursue overly expansionary policies that
are not discovered until too late, when successful speculative attacks
has undermined the economy. By also providing a more stable value of
the currency, exchange rate targeting might lower the true/perceived
risk for foreign investors. Lack of accountability of the central bank
under an exchange-rate target regime can make it harder to ascertain its
policy actions60. In contrast, exchange rate depreciation when the
exchange rate is not pegged can provide an early warning signal that
monetary policy is overly expansionary, and fear of depreciation can
60
Thailand, before the July 1997 currency crisis, serves as an illustrative case.
65
make overly expansionary, time-inconsistent monetary policy less
likely.
The general conclusions drawn with respect to this regime are that (1)
an exchange-rate target does not guarantee that the commitment to the
exchange-rate based, monetary policy rule is sufficiently strong to
maintain the target61, and (2) the cost to economic growth from an
exchange-rate regime with its loss of independent monetary policy can
be high.
By in large and as far as Arab economies are concerned, an important
reason for adopting exchange-rate targets is the underdeveloped nature
of the political, monetary and policy-making institutions. This has
undoubtedly undermined the ability of the relevant authorities to use
discretionary monetary policy successfully. One can argue that under
these circumstances, the loss of monetary policy independence can be
less costly—even advantageous, since a less-than-coherent monetary
order can have serious economic costs. Accordingly, many countries in
the region have recognized the benefits by effectively adopting the
monetary policy of a country like the U.S. rather than pursuing their
own independent policy.
61
Pre-EMU Netherlands’ guilder peg to the Deutsche Mark and GCC countries peg to
the U.S. dollar are two obvious exceptions.
66
There is also an important disadvantage of exchange-rate targets62
worth noting. Experience shows that such a regime in emerging market
countries managed to promote financial instability. Because of
uncertainty of the future value of the domestic currency, many
nonfinancial firms, banks and governments find it much easier to issue
debt if the debt is denominated in foreign currencies. This tendency
can be further encouraged by an exchange rate targeting regime that
may encourage domestic firms and financial institutions to issue
foreign denominated debt63. In this case, a devaluation of the domestic
currency increases the debt burden of domestic firms and with assets
denominated in domestic currency, the devaluation leads to a
substantial deterioration in balance sheets and a decline in net worth,
both for nonfinancial firms and financial firms which now are unable
to collect on their loans to nonfinancial firms. The deterioration of
balance sheets, by reducing effective collateral, makes lending less
62
63
Mishkin (1998).
Hausman, Panizza, and Stein (2000) argue that a country’s ability to borrow abroad
in its own currency can be used as a proxy for its ability to hedge its exchange rate
risk exposure. Measures of the ratio of foreign borrowing in own currency relative to
total foreign borrowing are used as proxies. The ratio of total foreign securities issued
in the country’s currency to total foreign securities issued by the country, can also be
used as an alternative. Higher values of these measures mean more flexibility in the
exchange rate is plausible (in accordance with the fear of floating view). Knowing
the extent to which foreign denominated debt is a prominent feature of the
institutional structure in Arab financial markets, and knowing how much foreign
denominated assets are readily available for matching purposes according to sound
asset/liability management techniques, would enable us to assess the vulnerability of
the financial system. Sound asset/liability management is a safeguard for a stable
financial system, if and when devaluation occurs, by protecting the net worth value
of nonfinancial and financial institutions from deteriorating. Table B2 in Appendix B
shows the ratio of Arab commercial banks’ foreign liabilities as a percentage of total
liabilities (in a number of Arab countries who made available the relevant data).
67
attractive and also increases moral hazard incentive for firms, which
leads to a decline in investment and economic activity. Under a weak
banking system, monetary authorities are in a weak position to defend
the exchange parity since increases in interest rates may further
deteriorate banks’ net worth, making a speculative attack on the
currency the more likely.
However, there are times when an exchange rate targeting makes
sense. Exchange rate targeting might be the only way to break
entrenched inflation expectations and stabilize the economy, in double
or triple-digit inflation economies. As far as Arab economies are
concerned, it is apparent that inflation is to a large extent under control,
with the exception of Sudan and Yemen experiencing higher than
average inflation. Over the last decade, Jordan, Algeria, Syria,
Lebanon and Egypt were quite successful in bringing inflation to
manageable levels64. In short, the argument that the potential use of
exchange rate targeting serves as a stabilization policy of last resort
cannot be accepted as the main reason behind its adoption in many
Arab countries. The popularity of the regime in the region has more to
do with circumstances all too specific to individual or group of
countries—features we now turn to highlight in more details.
64
In light of the large levels of underutilized capacity, more of a deflation problem
looms as a threat in countries like Jordan, Syria, and Lebanon (as was illustrated in
Table 4).
68
Nominal exchange rate anchors in AGCC countries65
All member countries of the AGCC officially, or effectively, peg their
currencies to the U.S. dollar. This policy has been guided by the broad
objectives of minimizing exchange risks for the private sector and
ensuring stable exchange rates among AGCC member countries.
Among other well known reasons behind such a peg we mention: (1)
the U.S. dollar is the unit of account used in pricing petroleum66; (2)
with countries highly dependent on oil revenues, a stable relationship
help fiscal authorities better plan; (3) AGCC countries’ imports from
the U.S. are large; and (4) dollar-denominated instruments constitute a
large portion of those countries’ external investments67. Based on this,
the relevant authorities in the Council have continued to favor a peg to
65
66
67
Abdel-Aziz Aldakhil (2000), “The euro and its impact on GCC economies” and
commentary by I. Dabdoub; in The Impact of the Euro on Arab Economies, Arab
Monetary Fund, F. Bin Jarada, editor.
The idea of switching the pricing of oil from dollar to euro on international markets
has been discussed recently. The main arguments for such a move is to avoid the risk
of excessive exchange rates fluctuations. A weaker dollar (a stronger euro) will
impact negatively on AGCC economies as a result of weaker real value for oil
exports. Also, paying the import bill for Europe in euros requisite an equivalent
amount of euros from oil exports. A counter argument is that, as in the case for any
international commodity, the currency with which a commodity is priced plays an
accounting role only; it simply transfers income from one currency to another but
does not determine the price of the commodity. The later is determined by demand
and supply forces. The process that determines the value of a currency and not its
pricing is the one that has an impact on exchange rate risk management.
Large AGCC governments’ investments play an important source for non-oil income,
especially in times of budget deficits. A fixing of AGCC currencies to an alternative
currency may expose the countries’ investment income to the risk of exchange rate
fluctuations.
69
the dollar68. They remain always vigilant and flexible in revising the
exchange rate arrangements on a timely basis in response to changing
economic conditions.
Note that AGCC countries might find it useful to target exchange rates
for reasons that have little to do with the conduct of monetary policy,
such as encouraging integration of the domestic economy with its
neighbors. Clearly this is the rationale for long-standing pre-EMU
pegging of the exchange rate to the mark (by countries such as Austria
and the Netherlands), and the exchange rate pegs that have taken place
in the run-up period to the EMU. However, if economic integration is
the goal, it is more likely to be accomplished by ‘currency union’
rather than an exchange-rate peg. This requires further exploration and
empirical scrutiny before AGCC members can seriously consider
carrying out the second part of the slogan “one market (with the
prospective customs union scheduled for 2003), one money”69.
68
69
The use of discretionary fiscal measures as effective stabilization tools (as a
substitute to monetary policy) in AGCC countries is assessed when drawing final
recommendations.
On October 13, 2001, finance ministers of the six-nation alliance of the Gulf Arab
states (AGCC) set 2010 as a target date for monetary union and a single currency
(with the US dollar to serve as a yardstick for the single currency, effective by 2010,
and with Kuwait given a “margin of movement against he dollar”). The ministers
also approved a five percent common customs duty on imports and decided to bring
forward the complete implementation of a customs union to 2003 from 2005.
70
Exchange rate anchors in other Arab countries
Jordan is adamant about preserving the stability of the Jordanian dinar,
subordinating the monetary policy and in particular interest rate policy
to this objective. Official interest rates have and continue to move in
reaction to changes in U.S. interest rates in preserving the stability of
international
reserves.
Prudent monetary
policy
during
1999
contributed importantly to the recovery of confidence and the rebound
in the demand for the dinar after the uncertainties of late 1998 and
early 1999.
Official foreign exchange reserves registered large
increases during 1999 and 2000 (close to 2.7 billion U.S. dollars). It
seems that the central bank policymakers’ preoccupation with
preserving confidence in the local economy, through stable demand for
the dinar and through comfortable levels of reserves, is an uppermost
concern.
However, this shouldn’t stop authorities from paying attention to
important developing trends in the economy. Although, the current
account as a percent of GDP, with the inclusion of grants, had shown a
surplus since 1997, the current account situation is reversed into
deficits when grants are excluded—for the period from 1995 to 2000
(with one exception of being balanced exactly in 1999)70.
70
A similar feature characterizes Jordan’s fiscal balances. Overall fiscal balances
before grants register deficits in percent of GDP almost twice the size of the fiscal
deficits after grants. It appears that grants have come to play a crucial role in
depicting a somewhat rosier picture of the financial health of the economy. Because
grants are not predictable or sustainable, expenditures planned and incurred on the
71
On the other hand, Jordan is currently going through a low output
growth period and creating demand is attracting the attention of
concerned policymakers. In this regard, we ask whether a weak
exchange rate can make it possible to grow income through exports.
Export strength must be achieved either from healthy global demand71,
or from more competitive currencies. In the case where comfortable
levels of foreign exchange reserves have existed, the exchange rate
policy would remain credible and won’t lead to wrong expectations of
the central bank’s intentions if and when the authorities decide on
allowing more flexibility in the exchange rate72. Fiscal stimulus, on the
other hand, is a substitute for a weak currency in terms of creating
demand. But in light of the fiscal deficits and debt burden of Jordan,
there isn’t much fiscal power to fret about. It is also important to keep
71
72
assumption that grants will continue at current rates can seriously distort fiscal
planning and force a severe adjustment in the future if the assumption turns out to be
optimistic.
However, the outlook for global demand for Jordan’s primary traditional exports
(phosphates, potassium, cement) is bleak.
Whichever indicator of foreign exchange adequacy is used (more recent indicators
have focused on financial vulnerability, such as the stock of short-term liabilities—a
practice recently adopted by Tunisia), the nature of the exchange rate regime plays a
part in determining the adequacy of the reserve level. Traditionally, the presumption
has been that a country with a fixed rate needs larger reserves than a country with a
floating rate regime since, with a fixed rate, reserves are the only cushion for
absorbing shocks. However, if confidence in the authorities’ ability to maintain
supporting policies is high, a country with a fixed exchange rate may not require
large reserves to defend its currency. At a fundamental level, the credibility of the
authorities’ economic policies and the confidence that market participants place in
them are the more important factors in assessing the adequacy of reserves. Indeed, it
is credible policies that allow the authorities to augment reserves by borrowing
abroad at favorable terms; borrowed reserves can provide a major supplement to the
country’s own reserves for countries with access to international financial markets.
72
in mind that demand stimulus alone, brought about either through a
weak currency or through fiscal spending, will be ineffective unless
structural problems are addressed (Taiwan and Japan are two cases that
come to mind).
More recently, Egypt rightly recognized an overvaluation problem in
its real effective exchange rate and consequently allowed the pound to
depreciate to fetch its equilibrium market value. In the last few years,
the foreign exchange market in Egypt faced consecutive disturbances
reflecting on one hand the gap between resources and uses, and on the
other the expectations effect about the future of the Egyptian pound
that was nurtured by speculative activity. As a result, an initiative for
multiple exchange rates initially surfaced and was followed by
multiple activities in the foreign exchange market accompanied by
destabilizing forces to the economy.
In order to bring these negative effects under control, efforts aimed at
strengthening the role of market forces in determining the exchange
rate were undertaken, commencing January 31, 2001. A central rate
determined according to market forces was put in place and later
considered as a basis to establish a transaction rate among all
participants in the market, banks and exchange bureaus alike. A central
rate of 385 piasters to the dollar (with a margin of ± 1%) was used to
determine the US dollar price, with other foreign currencies’ prices
determined on the basis of the latter relationship with the dollar in
foreign markets. The banks here announce their wishes to buy or sell
73
foreign exchange through the “central chamber” of the free foreign
exchange market. It was perceived that this announcement effect has
instituted the required transparency for the exchange rate regime and
the mechanics through which it operates.
In August 2001, the current arrangements were amended by increasing
the central rate to 415 piasters to the dollar and widening the margin to
± 3% from 1% and since then, the average transaction rate has been
computed based on a simple averaging method rather than a weighted
one. Early assessment of the changes points to their impact in
stemming off the multiplicity in exchange rates. Furthermore, the more
flexible and transparent initiatives also helped narrow the difference in
prices between banks and exchange bureaus while bringing more
stability to the foreign exchange market and enhancing the role of the
interbank market.
In Lebanon, many experts are calling for allowing the exchange rate to
depreciate in light of its misalignment from its equilibrium market
value73. Estimates of the overvaluation of the Lebanese exchange rate
73
A. Kubursi (2000) calls for resisting temptation of a flexible regime on the premises
that it provides a shelter behind which unproductive manufacturers hide rather than
take measures to improve productivity. However, I must add that it is hard to
reconcile that a single macroeconomic factor, such as the behavior of the exchange
rate, plays a crucial role in undermining productivity growth. If anything, the bulk of
the available research suggests that the causal link between productivity and currency
goes in the other direction. Exchange rate depreciation could be a symptom and not
necessarily the cause of a country’s declining economic welfare. An alternative
argument proposed by advocates of a pegged system in Lebanon is (1) to preserve the
hard-won fight against inflation—recall Lebanon is heavily dependent on imports to
74
range between 18% and 40% and this magnitude is growing over time.
Continuing with maintaining a firm grip on the exchange rate may
have gained the authorities the reputation as being staunch defenders of
the peg and consequently reinforced the authorities’ much sought-after
credibility. But this doesn’t necessarily mean that the costs of such
actions do not exist. I explain further. Fixing a relative price like the
exchange rate doesn’t make the problem go away. It simply transfers
the burden of adjustment elsewhere. If an economy is subject to serious
and frequent macroeconomic disturbances, and the nominal exchange
rate is not allowed to adjust to help offset them74, the resulting
economic pressures are typically shifted onto other variables, while the
economy is trying to re-equilibrate after the shock. Under relatively
(downwardly) sticky prices and wages and less than perfect mobility in
factors
of
production—features
observed
in
most
real-world
economies—the result is often greater variability in output and
employment than would have been the case if the exchange rate had
74
meet its domestic demand; and (2) the fear of floating in Lebanon which de facto peg
to the dollar is based on the country’s large accumulated foreign debt that has to be
paid. Recent 2001 estimates of Lebanon’s debt to GDP range between 160-170%, up
from 153% in 2000.
To resist a downward pressure on the currency when it originates in some shock to
fundamentals that lowers the economy’s equilibrium real exchange rate would,
(assuming that price inflation in the anchor country remains negligible), require the
domestic price level to move downward, and perhaps the money-wage level too.
These adjustments might be exacerbated by higher interest rates needed to attract an
extra capital inflow sufficient to offset the trade account deterioration that would
persist until the real exchange rate was back in equilibrium. As well, in the presence
of nominal stickiness higher unemployment and lower output would be integral
components of this adjustment. Regardless of its source, downward pressure on the
currency would always produce extra difficulties stemming from the fact that foreign
exchange reserves are necessarily finite.
75
been allowed to move. The exchange rate uncertainty and destabilizing
economic forces that one had hoped to eliminate by fixing the currency
may simply manifest themselves elsewhere—in a less obvious but
potentially more damaging form. It is high time for policymakers in the
country to justify the incurrence of such costs and to speed up its
corrective reforms in order to ease up the pressure on the pound.
I suspect that once the debate intensifies—as it almost certainly will in
the months or years ahead—it will become apparent that there is no
miracle solution to the pound’s plight being under pressure. Just
choices, all of which are difficult. Instead of contemplating solutions to
the pound, it would be more productive to focus on policies to promote
stronger economic growth which may, who knows, even help to ease
the pressure on the Lebanese exchange rate. Hopefully and ultimately
it will be economics that will carry the day and not politics that will
decide the issue.
In wrapping up, we put it simply, the kind of change in fundamentals
that produces a depreciation under a flexible exchange rate can, under
a pegged rate, lead to a foreign exchange crisis. Such crises produce
downward pressure on the domestic economy, in addition to that
needed to adjust the real exchange rate to fundamentals, and are all too
often resolved by devaluation or the re-establishment of a floating rate.
76
Other monetary policy frameworks in Arab economies
According to Table A3, Tunisia and Yemen are classified as following
a monetary aggregate targeting (an M4 growth objective in the case of
Tunisia). In light of structural and institutional changes and
technological innovations in financial systems, the tenet that
guarantees the success of such a regime, namely stable empirical
money demand relationship is subject to a breakdown. Such a regime
in which monetary aggregate becomes the intermediate target of
monetary policy has lost its popularity75.
As of yet no single Arab country applies the direct inflation-targeting76
regime. Such a regime gained popularity particularly in countries
where exchange rates became harder to defend and money more
difficult to target. The unhappy experience with pegged exchange rate
regimes led emerging-market countries to consider inflation targets as
75
76
Even Germany’s success with such a regime is attributed to a pragmatic application
of it, looking more like an inflation targeting regime than anything else that
resembles a Friedman-rule approach.
The 1990s have seen the adoption of this new approach to the conduct of monetary
policy, by a growing list of countries. Inflation targeting has so far been very
successful in the countries that have adopted it. Inflation-control targets are by no
means a miracle solution for monetary policy but experience shows however that
they provide a framework that leads to better policy decisions, better economic
performance over time, and a more accountable, and therefore more sustainable,
position for autonomous central banks. Also, explicit inflation targets are not by all
means the only way to achieve good macroeconomic results. Indeed, the worldwide
reduction of inflation in the 1990s across countries (Arab countries included) with
different frameworks for monetary policy clearly indicates that there are a number of
ways to achieve low inflation.
77
an increasingly attractive alternative77. The bottom line is that,
although inflation targeting is not a panacea and may not be
appropriate for many Arab countries (not in the foreseeable immediate
future), it can be a highly useful monetary policy in a number of them
provided two crucial prerequisites namely, sounder banking systems
and more fiscal discipline are put in place78.
The remaining monetary policy regime is the Fund-supported or other
monetary program, as it appears in (Table A3). This involves
implementation of monetary and exchange rate policy within a
77
78
It has been adopted by a number of emerging-market countries—Chile, Brazil, the
Czech Republic, Mexico, Peru, Poland and South Africa. Turkey is considering
adopting inflation targeting.
A high degree of (partial) dollarization may create a potentially serious problem for
inflation targeting. This problem is likely to materialize in countries where the
balance sheets of firms, households, and banks are substantially dollarized, on both
sides, and the bulk of long-term debt is denominated in dollars. Because inflation
targeting necessarily requires nominal exchange rate flexibility, exchange rate
fluctuations are unavoidable. However, large and abrupt depreciations may increase
the burden of dollar-denominated debt, produce a massive deterioration of balance
sheets, and increase the risks of a financial crisis. This suggests that those countries
cannot afford to ignore the exchange rate when conducting monetary policy under
inflation targeting, but the role they ascribe to it should be clearly subordinated to the
inflation objective. It also suggests that inflation targeting in partially dollarized
economies may not be viable unless there are stringent prudential regulations on (and
strict supervision of) financial institutions that ensure that the system is capable of
withstanding exchange rate shocks. On the other hand, absence of outright fiscal
dominance and a sound financial system (when financial systems blow up, there is
typically a surge in inflation) are essential prerequisites for successful inflation
targeting. Mishkin and Savastano (2000) point out that the two prerequisites are also
crucial to the sustainability and success of any other monetary policy strategy,
including a CBA or full dollarization. To the extent that government is involved in
setting the inflation target, an advantage of inflation targeting here is that it may help
constrain fiscal policy.
78
framework that establishes floors for net international reserves (NIR)
and ceilings for net domestic assets (NDA) of the central bank. The
(NIR) floor establishes a ceiling on foreign exchange market
intervention in the presence of an exchange rate target; when the
ceiling is hit monetary policy is tightened to defend the exchange rate
or the exchange rate is allowed to adjust. Ceilings on (NDA) limit base
money increase through central bank operations. Indicative targets for
bank reserves may be appended to this system, rendering it a multiple
anchor framework. Djibouti, Jordan, Mauritania, Sudan and Yemen are
classified as being under an IMF supported program. Egypt’s monetary
authorities, on the other hand, intend to guide monetary policy using a
range of indicators, given uncertainties in money demand.
The role of the exchange rate under alternative monetary
frameworks
The exchange rate always has an important role to play. There is no
one central bank in the world that does not care, implicitly or
explicitly, about its country’s exchange rate. Changes in the exchange
rate can have a major impact on inflation, particularly in small, open
economies. For example, a depreciation of the currency can lead to a
rise in inflation because of the pass through from higher import prices
and greater demand for the country’s exports. An appreciation of the
currency on the other hand can make businesses uncompetitive79.
79
Mishkin (2000) … In emerging market countries, concerns about exchange rate
movements are even greater. Real appreciation makes domestic industries less
79
The avoidance of a target for the exchange rate does not imply an
indifferent central bank toward exchange rates. As just mentioned in
footnote 76, this issue is particularly relevant for countries with a lot of
foreign denominated debt. Central banks in these countries may thus
have to smooth “excessive” exchange rate fluctuations, but must make
it clear to the public that they will not preclude the exchange rate from
reaching its market-determined level over longer horizons (Lebanon
and Egypt are two cases in mind).
The fact that exchange rate fluctuations are a major concern in so many
countries raises the danger that monetary policy may put too much
focus on limiting exchange rate movements. This can induce the wrong
policy response when a country is faced with real shocks (such as a
terms of trade shock). The idea behind the Monetary Conditions
Index80 is that both interest rates and exchange rates on average have
offsetting impacts on inflation. When the exchange rate falls, this
usually leads to higher inflation in the future, and so interest rates need
80
competitive, but it can lead to large current account deficits, which might make the
country more vulnerable to currency crises if capital inflows turn to outflows. As
seen, depreciations are particularly dangerous because they can trigger a financial
crisis in light of their debt denominated in foreign currency.
MCI is a weighted average of the exchange rate and a short-term interest rate. In
Canada for example, to carry out monetary policy, the central bank tracks monetary
conditions with the MCI. The information provided by the MCI helps to guide the
monetary policy decisions. New Zealand’s abandoned the use of the MCI in 1999,
placing far less emphasis on the exchange rate in its monetary policy decisions. New
Zealand may be the only country in the world that can truly qualify to be classified as
a pure floating exchange rate regime.
80
to rise to offset the upward pressure on inflation. However, the
offsetting effects of interest rates and exchange rates on inflation
depend on the nature of the shocks to the exchange rates. Exchange
rate depreciation as a result of a negative terms of trade shock, which
decreases the demand for a country’s exports, is thus likely to be
deflationary. The correct interest rate response is then a decline in
interest rates, not a rise as the MCI suggests.
This all works to show that interpreting exchange rate movements and
responding with appropriate policies is a delicate matter and requires a
high degree of technical capacity at the central banks’ level, regardless
of the country’s development stage and of the operating monetary
framework in place.
81
IV. Recommendations for Future Directions
We are guided by the key policy implications of Mundell’s pioneering
analysis that there does not exist one universally preferable exchange
rate arrangement at all times and in all countries as a great deal of
changes affect economies over time. The importance of debating the
merits of alternative exchange rate regimes in a framework of a
“coherent monetary order” is also very crucial81.
It was observed that Arab economies differed substantially from one to
another in many respects despite the commonality in culture and
language. Differences in economic structures and financial systems, in
the degree of capital account liberalization as well as differences with
respect to the developmental level of institutions were closely
scrutinized in assessing the exchange systems and policies in the
region. While certain exchange rate regimes in Arab countries are
currently deemed viable in light of their current economic and financial
conditions, others are under pressure to undergo key reforms in
policies in light of the exigencies of the new domestic and global
challenges
81
facing
them.
Key
world
developments
such
as
One should keep in mind that such a framework takes time to be well established and
should be put in place piecemeal. Less-than-coherent monetary orders can have
adverse consequences on the real economy. In this regard, any one regime could be
compatible with many monetary orders, including the badly configured ones. It could
be that problems with the monetary order and not the exchange rate regime itself that
contribute to a country’s economic difficulties …Laidler (1999).
82
globalization, liberalization in exchange controls, innovation, the
introduction of the euro and the impact of regional trade liberalization
as in the case of the Association Agreements with the European Union
(AAEUs), among many other things, are likely to exert an important
influence on the exchange rate arrangements of those countries. At a
country level, a large number of Arab countries have implemented
wide-reaching stabilization and structural reforms. On the macro track,
demand management policies successfully brought inflation and fiscal
deficits under control and large external imbalances were reduced. On
the other hand, it is taking time for the productivity-enhancing reforms
ranging from liberalized trade regimes, to privatization plans and
friendlier environment for foreign direct investment, to become
effective—reasons that are behind the low growth rates in the region.
This section endeavors to pinpoint weaknesses in the economies of the
region while focusing on the role that the exchange rate came to play
in this regard. While a loss of competitiveness was evident in all three
groups of economies highlighted in section III, the overvaluation in the
exchange rate seems to be a lesser problem for the handful of countries
that permitted flexibility in the exchange rate. Issues ranging from
diversifying the production base, reducing dependence on oil exports,
enhancing the authorities’ credibility and securing financial stability
are examined on a country-by-country basis.
As previously mentioned, the exchange rate arrangement is merely a
technical arrangement, and on its own cannot substitute for sound
83
underlying economic policies. Sound financial policies, supportive
structural policies particularly important in securing productivity gains,
as well as prudent demand management policies all work in a
complementary way to achieve the optimal exchange rate regime for a
country. It is also in light of the region willingness to become
integrated into the global economy through exchange and trade
liberalization that recommendations concerning the relevant exchange
rate arrangements and potential reforms are presented. We begin by
assessing the impact of the euro and the (AAEUs) on the exchange rate
management in the region, before recommendations are drawn on a
country-by-country basis.
The euro and Association Agreements with the European Union
(AAEUs)82
For most Arab countries, there was no mentioning of an immediate
change in exchange rate policies in response to the introduction of the
euro. Understandingly, the euro may however trigger possible changes
in policies: (1) if it does prove to be more or less stable vis-à-vis the
leading currencies, in particular the U.S. dollar; (2) if it becomes a
competitor to the U.S. dollar in its role as a unit of account; and (3) if
82
Allum and Nashashibi (2000), “ The macroeconomic impact of the euro on Arab
economies” in F. Bin Jarada, editor. Allum, Enders and Nashashibi (1998),
“European Monetary Union: Impact on the MENA region”, IMF Occasional Paper
174, section III. See also, Al- Mannai (2000) for a brief summary of the euro on the
GCC economy and finance.
- See H. Ghesquiere (2001) for a discussion of the impact of the AAEUs on
Mediterranean countries.
84
the euro speeds up the process of economic and financial integration
between Europe and the Arab world—each of which may by itself has
an impact on the conduct of Arab exchange rate policies.
One consequence in changes in the value of the euro pertains to trade
competitiveness. A depreciation of the euro relative to other
international currencies could result in a loss of competitiveness in
European markets for those countries with strong currency links to the
U.S. dollar83. On the other hand, EMU will also give some Arab
countries a degree of additional exchange rate assurance, to the extent
that the introduction of a single currency would eliminate the risk of
large devaluations of individual currencies within the EU group.
Changes in the valuation of the euro can also have implications for the
terms of trade of Arab countries dependent on EMU markets for
exports—but non-EMU markets for imports—if export prices are
determined by the currency of the export market and import prices by
the currency of the country of the origin.
In the MENA region84, countries currently maintain a variety exchange
arrangements and pursue widely different exchange rate policies.
Morocco and Tunisia already have links to EMU currencies, through
83
84
With respect to exports, euro fluctuations would be primarily important for Syria and
Egypt as the EU markets account for 55 and 44 percent of the total exports of those
countries, respectively. For the oil-exporting countries pegged to the dollar, export
prices are determined in world markets, and competitiveness is relatively unaffected
by exchange rate movements.
Included here are the countries of Algeria, Egypt, Jordan, Kuwait, Lebanon, Libya,
Morocco, Saudi Arabia, Syria and Tunisia.
85
the currency baskets underlying their exchange rate policy. For them,
the implementation of exchange rate policy to manage external
competitiveness need not be changed in view of potential changes in
the value of the euro. The exchange rate policy in other MENA
countries—whether in the context of announced pegs or not—is aimed
at maintaining nominal stability vis-à-vis the U.S. dollar. For the nonoil countries with currencies linked to the dollar and large trade shares
with the EU countries, there may be merit in considering linking to a
broader basket or switching to a more flexible exchange rate policy
that might better preserve relative price stability against European
markets. This decision depends on a variety of factors including the
effectiveness of exchange rate adjustment in achieving relative price
movements; the type of shocks affecting the MENA region; and the
currency composition of merchandise and services trade flows, migrant
workers’ remittances and debt-service obligations85. In order to avoid
the effects of exchange rate movements, it may be desirable in this
regard for countries to adjust their exchange rate regimes to better
reflect the composition of their trade and financial links or change their
debt management policies.
85
As far as debt-service obligations, exchange rate movements could have important
effects on countries with substantial external debt, over and above the impact of
EMU on trade and investment flows. In selected MENA countries, a large proportion
of debt is denominated in EU currencies—Syria with the highest proportion at close
to 80%. In the event of a mismatch between the currency denomination of the debt
and the anchor of the exchange rate regime or the currency mix of trade partners, an
appreciation of the euro would benefit countries that peg to the euro and export
primarily to euro-area countries but service a substantial debt denominated in dollars.
86
In light of the increased capital mobility in the particular group of
MENA economies that have a nominal exchange rate anchor (with the
exceptions of Syria and Libya), there may be advantages in promoting
increased exchange rate flexibility quite independent of the
introduction of the euro. In addition to facilitating adjustments in
relative prices as external reforms lead to changes in MENA countries’
equilibrium real exchange rates, greater exchange rate flexibility would
also allow MENA countries to respond in a flexible manner to shifts in
the value of the euro relative to other currencies in the short-term and
to shifts in competitiveness or foreign direct investment following the
onset of EMU86.
For many Arab countries of the MENA region, the evolution of trading
relations with the EU will be affected over the coming years not only
by EMU but also as a result of the implementation of Association
Agreements with the European Union (AAEUs) which fall under the
framework
of
the
broader
Euro-Mediterranean
Partnership
Initiative87.
86
87
Of course the advantages of greater flexibility need to be balanced against other
traditional OCA arguments in favor of close links to the currency of a major trading
partner such as the EMU area. In all, we remind the reader of the essential role of the
supporting macroeconomic and financial structural policies in reaching an optimal
exchange rate regime.
Tunisia, Morocco, and Jordan, among other countries in their region, have concluded
such agreements. Negotiations are advanced with Egypt and Lebanon, and are under
way with Algeria and Syria.
87
It is perceived that the agreements provide a major impetus toward an
open trade regime over the next decade or so and constitute a catalyst
for overall economic reform. In a rapidly changing world of
globalization, the signatories’ small open economies are establishing
free trade for industrial products with the success of the agreements
hinging on the Mediterranean’s countries ability to generate a critical
mass of foreign investment in labor-intensive, export-oriented sectors
rather than inward-looking, low profitable labor intensive activities.
In light of the added competitive pressures that will result from trade
liberalization, and to prevent a deterioration of domestic and external
balances, the macroeconomic policy response is that, in conjunction
with structural reforms and fiscal consolidation, a more flexible
exchange rate policy in response to market forces could play an
important role in strengthening competitiveness and spurring faster
growth. The benefits of a flexible exchange rate in improving
competitiveness are advocated, in the early stages, to complement the
role that he expected productivity gains (realized as structural reforms
take hold—albeit, with a considerable time to become effective) will
come to play in improving competitiveness. Allowing real exchange
rate depreciation, if and when needed, will work to preserve the
strength of the external accounts without jeopardizing financial
stability.
88
The Arab countries: case-by-case
AGCC countries: These countries have followed a pegging to the U.S.
dollar regime since the early eighties88. The viability of such a peg has
a lot to do with the huge financial armory in place to defend it against
any attack. Two quick recommendations are made as far as the single
currency and the use of fiscal policy as a substitutable stabilization tool
are concerned.
On the adoption of a common currency recently declared in a meeting
of the AGCC ministers of finance, and in order to properly assess the
viability of the arrangement, it is advisable that the institutional and
structural characteristics of the alliance members and the way they
respond to external shocks be further studied. Although not tested
empirically, it seems little would be lost, in terms of insulation or
policy effectiveness if AGCC currencies were linked under a monetary
union. It is argued, countries that are so inexorably bound, and growing
ever more integrated, should be natural candidates for a common
currency89. Very briefly, some of the things favoring a move as such
88
89
The say that any devaluation in the currency is an enticing factor as it makes exports
cheaper on the international markets does not apply here. GCC export, among other
products, oil, petrochemicals, liquefied natural gas, and steel. The prices of these
products are in dollar and are determined in the world markets through forces of
supply and demand; they do not benefit from depreciation in the local currency. A
strong dollar in most likelihood will not affect markets negatively, as on the contrary
it has helped reduce inflationary pressures and has increased the purchasing power of
the consumer in the Council.
The following is a check list serving as criteria for assessing the viability of such an
arrangement: (a) the stability of monetary orders between members; (b) the size of
89
are the following: the economies are highly integrated and share many
important characteristics; they are in close geographic proximity; their
citizens travel extensively between the two countries; and they share
similar values, culture, and history; gains in terms of reduced
transactions costs and the elimination of currency risk can be
important; savings in terms of transactions costs incurred in the AGCC
foreign exchange markets can be realized.
On the other hand, it is perceived that a flexible exchange rate is
somewhat redundant under a system of fiscal transfers. Such a system
can be activated through subsidies or special social assistance,
whenever the region or an industry therein is hit by an external shock,
trade between members and geographic proximity; (c) flow of capital between
countries; (d) transactions costs’ savings and the elimination of currency risk; (e)
costs (to firms and households) of adapting to new domestic unit of account; (f)
existing legal barriers to inter-country labor mobility; (g) composition of countries’
output—common important characteristics; (h) degree of wage–price flexibility; (i)
the role of fiscal policy; (j) problems of fundamental political importance; (k) degree
of integration of the banking systems; (l) the coverage of the payments system
(union-wide?), and (m) degree of commonness in the regulatory framework.
-This first concrete step in adopting a single currency brings to the forefront a much
debated issue—that of adopting a single currency in the entire AMF membership. A
monetary system exists to facilitate trade in goods, services, and capital. Just as the
growing integration of their real economies as a result of a common-market
arrangement has led European countries towards monetary integration, so do other
free trade agreements (the Greater Arab Free Trade Agreement launched in 1997, in
the context of the Arab region) offer the starting point for a similar process of
integration—or so it is argued. Despite the Arab countries’ call for a monetary union
well before the Europeans, more concerted efforts and preparation need to be
seriously undertaken before such an idea comes to fruition since it is ill-advised to
disregard wide discrepancies that currently exist on many economic fronts. The
criteria for assessing the viability of such an arrangement include a long list of
conditions of differing economic and political weights—it goes well beyond the
rhetoric of “one nation, one money”.
90
until conditions improved. Accordingly, AGCC countries have
afforded dropping the monetary policy as a stabilization tool in light of
the compensating role of its fiscal policy. A word of caution on the use
of discretionary fiscal policy for stabilization purposes is in order here.
In the last few years, periodical oil price shocks have imposed serious
constraints on the countries’ financial resources, which led many of
them to ration government expenditures and re-define expenditures
priorities90. Discretionary fiscal measures often lack the necessary
speed and focus to serve as effective stabilization tools and are difficult
to reverse once the shock has passed. Additional problems arise if the
shock is permanent and the fiscal expenditures inhibit necessary longrun economic adjustments. There is also a risk that trading partners
might complain about the subsidies offered to certain industries under
these schemes and retaliate with countervailing duties and other antidumping measures. In short, discretionary fiscal measures and other
90
In its first ever published annual review of the Saudi economy, the IMF warned that
the Saudi economy remains vulnerable to downside oil price risks, which could put
extra strain on fiscal and external balances (where export earnings are heavily
dependent on oil). Recent developments show that the risk premium being charged to
lock in the riyal’s exchange rate one-year forward (SARF) rose to around 4.4 percent
in November 2001—there is empirically a strong correlation between the oil price
and the one year SARF. Recall that during the Asian crisis, in November 1998, risk
premiums hit 1,000 basis points intra-day at one point. Repeatedly and particularly
during periods of sharp price changes in crude, mounting political pressure on the
riyal peg is becoming more and more a recurrent theme. In light of the strength of the
economy and the hefty reserves under lock, it is believed that the peg remains
sustainable in the short-term. While a pegging system is here to stay, it is perceived
that a more diversified economy is better equipped to lessen arising pressures on the
external balances in the region.
91
government actions are unlikely to be a perfect substitute for flexible
exchange rates91.
Egypt: Over the recent past, the Egyptian authorities have allowed
significant depreciation to the exchange rate. By the end of 1999, we
mentioned that the Egyptian pound was under pressure and that the
authorities at that time didn’t adopt a clear and acceptable policy to
regain equilibrium in the foreign exchange market (the LE was trading
at 3.45 per U.S. dollar within narrow bands). The resulting shortage in
foreign currencies and the increase in the interbank interest rate on the
LE prompted the authorities to adopt a crawling peg regime against the
dollar, where the exchange rate was fixed at LE 3.85 per U.S. dollar
while allowing the currency to fluctuate within a currency band width
of plus or minus 1%.
The last changes introduced in August 2001 to the exchange rate
system allowed a 6.5% depreciation of the central rate (from LE3.90 to
LE4.15 per U.S. dollar) on top of the significant depreciation over the
past year92. It is apparent that the crawling peg strategy first instituted
91
92
Experience with them has not been very encouraging. Obstfeld and Peri (1998)
provide a skeptical view on the usefulness of fiscal transfers as an adjustment
mechanism.
-See Karam (2001) for a review of fiscal frameworks, targets and government
accounts.
-See also Chalk. N (2001) for a discussion of the fiscal sustainability in oil-producing
countries, in I. Zubair.
Egypt devalued its currency to a core rate of 4.50 pounds to dollar on December 13,
2001, while allowing the pound to trade within the same currency band width of plus
92
as a reform to the exchange rate regime is following in its transition
path towards greater flexibility. Box 4 highlights some essential
elements in the transition path to a flexible exchange rate and the exit
strategies involved in such a migration toward greater flexibility.
It is believed that the latest rounds of depreciations are working toward
further strengthening competitiveness, helping to boost exports and
economic growth. The doubling of the currency band width to plus or
minus 3% is expected to provide greater room for the exchange rate to
respond to changes in economic conditions. Such a commitment to
continuing exchange rate flexibility seems to be adequate in light of
Egypt’s further integration into global markets. A flexible regime
would allow Egypt to ride out periods of market turbulence and
weather any external shocks while avoiding further significant declines
in official reserves from the currently relatively strong position.
External competitiveness is more likely to be maintained in an
environment of a liquid foreign currency market and a currency band
that is allowed to be adjusted in response to market conditions.
or minus 3%. Anecdotal evidence point to the sale of dollars outside the legally
allowed limit (the weakest being 4.635) by Egypt’s exchange bureaus.
93
Box 4. Transition Path and Exit Strategies Towards Exchange Rate
Flexibility
Transition path to a flexible exchange rate regime
It was mentioned that as countries’ ability to hedge their exchange rate risk
exposure is gained, and as those countries not yet integrated in the global
financial system increasingly become so, flexible exchange rate regimes
become more viable as an alternative to a pegged system. Increased exchange
rate flexibility may take a variety of forms: (1) allowing
appreciation/depreciation of the currency within a relatively flexible regime
(Malaysia, Peru, Philippines, South Africa, Turkey); (2) allowing greater
flexibility within pegged or tightly managed systems; (3) introducing bands
around a fixed parity and successively widening the band (Czech and Slovak
Republic, Korea); (4) moving to a crawling band from a crawling peg or a
horizontal band, successively widening the band, and adjusting the rate of
crawl (Hungary, Israel, Russia); (5) floating the exchange rate (Malaysia
before 1997). Figure A illustrates diagrammatically a particular transition
path from a fixed pegged regime to free float. One Arab country at least
(Egypt) can be described as being on a transition path toward greater
flexibility in its exchange rate regime.
Exit strategies towards exchange rate flexibility
Exchange-rate-based stabilization programs were successful in reducing
inflation and imposing policy discipline for a period of time93. More often
93
Typically, an initial and often large devaluation was followed by a predetermined
path of depreciation for the exchange rate, aimed at boosting the external position,
reining in monetary growth, and imposing fiscal discipline by limiting financing from
the central bank.
In light of the entailed real exchange rate appreciation, current account deteriorated
leading to the programs being short-lived. As the real exchange rate rises, especially
if inflation is not reduced sufficiently fast, the conflict between the authorities’
objectives of reducing inflation and maintaining competitiveness becomes
increasingly apparent, raising the probability of a speculative attack.
94
Box 4…continue
than not, the end of a peg under such programs came about with disruptions
to the economy. A well thought “exit” strategy could prevent disruptions of
this kind94.
For Arab countries considering a changeover from pegged to more flexible
regimes, the following is presented as tested guidelines for ensuring success
along the transition path. It is best to allow a regime shift during a period of
calm or upward pressure on exchange rate while timing the shift before
strong real appreciation and exhaustion of net international reserves. The
exchange rate anchor must be replaced by clear commitment to low inflation
(a credible new anchor for monetary policy) while retaining the exchange rate
as part of an overall policy package. Central bank operational independence,
institutional and technical capacity to conduct monetary policy (underlying
all that a clear mandate for monetary policy to pursue price-stability
objective), disciplined, transparent and more flexible fiscal policy, as well as
strong, deep and well-developed and supervised financial sector,
strengthened prudential regulations, are all essential conditions that facilitate
an orderly exit. Creating effective foreign exchange market95 is also desired
when exiting.
94
95
The need to move away from a soft peg is one of the reasons an exit mechanism was
built into the Turkish stabilization and reform program that began in December 1999.
The intention is that a band around the crawling peg will begin broadening in the
middle of this year, and continue broadening through the end of 2002. The recent
difficulties in Turkey relate more to banking sector problems, and the failure to
undertake corrective fiscal actions when the current account widened, than to the
design of the exchange rate arrangement. Corrective measures in both these regards
have been agreed and are being implemented.
In moving towards flexible regimes, the role played by retail foreign exchange
markets (i.e., exchange houses and foreign exchange bureaus) becomes more
important since they are in closer contact with market forces and detect more
promptly official exchange rates that are off equilibrium. The level of development
of these markets in Arab countries is worth exploring.
In order to promote a continuous interbank foreign exchange market, it is essential to
enlarge the size of the market, tackle insolvency problems of banks, allow
participants to play an active role in allocating and pricing the foreign exchange and
allow authorized dealers to assume the leading role in setting buy-sell quotations
95
Box 4… continue
In a normal period, a gradualist pre-announced strategy is followed,
whereas in crisis situation the exit is toward more flexible regime
provided inflation pressures are under control.
Figure A. Fixed pegged rates to free float
C r a w lin g B a n d
Peg
Free Float
M a n a g e d F lo a t
B an d
Jordan: The fixed exchange rate to the U.S. dollar allowed Jordan to
follow an exchange rate regime similar to that followed in AGCC
countries—economies with which it has strong economic and trade
relations. Accordingly, the fixing of the exchange rate against the
dollar has encouraged the flow of Jordanians savings working in Gulf
countries. In addition, it has helped to attract foreign direct investment
rather than the central bank, enforce prudential regulations, remove restrictive foreign
exchange control laws (eliminate taxes and surcharges on foreign exchange
transactions and liberalize surrender and repatriation requirements as in the case of
Algeria), build trust between dealers and, finally, eradicate inefficiencies in payments
and communication systems.
96
and it supported tourism and other services sectors which exports to
AGCC countries96. Moreover, the fixed exchange rate policy has
helped reduce the risks of a weaker Jordanian dinar (an uppermost
concern with the savers and investors in Jordan), and has undoubtedly
stabilized the foreign exchange market. Given the circumstances and
local exigencies of the local economy over the last few years, a pegged
system may have well been the suitable choice.
On the other hand, fluctuations in oil prices and declining proceeds
from oil trade have can also negatively affect, in an indirect way, the
Jordanian economy through lower transfers and remittances from oilexporting countries and lower import demand in the region.
Consequently, efforts to diversify its production base to reduce
dependence on oil developments and to penetrate new markets outside
the region (recall Jordan having concluded the AAEUs) may be a good
reason to allow more flexibility in the exchange rate. Looking forward,
and in light of surfacing fiscal and current account imbalances (once
grants are excluded), the monetary authorities in Jordan should be
flexible in their view on preserving the exchange rate constancy over
prolonged periods of time, particularly under a regime where capital
flows freely.
96
The primary exports in Jordan (phosphate, potassium and cement) are all priced in
U.S. dollar. It is argued that similarly to the AGCC case, any depreciation in the
currency is unlikely to add to its market value in the world exports markets.
97
Lebanon:
The loss of competitiveness, which has an impending
negative effect on growth, is largely due to the substantial appreciation
of the country’s real effective exchange rate under a pegged currency
to the U.S. dollar. The financing of the government sizeable fiscal
deficits from banks resulted in a financial crowding out of private
spending by the public sector (as banks are forced to reduce credit to
the private sector). More recently, the central bank has increasingly
played a more important role in meeting government’s financing
needs. Under a fixed exchange rate regime and unchanged interest
rates, the expansion in central bank financing has led to a serious
deterioration in its external reserve position. While the authorities’
commitment to revive economic growth and consolidating the public
finances over the medium term are encouraging, more convincing debt
reduction strategies are needed. In relation to this point, allowing an
exchange rate adjustment in conjunction with prudent fiscal and
monetary policies and speedy structural reforms is crucial to the
country’s success in facing the mounting economic challenges. While
flexibility in the exchange rate is deemed beneficial, the specific
circumstances of the country may requisite something akin to a
crawling peg to mitigate the risks involved in exiting a pegged regime.
For those advocating a continuation of the peg regime, the ability of
maintaining such a regime hinges on the success in correcting very
large and persistent macroeconomic imbalances and on removing
structural and administrative impediments.
98
Mauritania: Given a comfortable level of reserves (in relative terms to
the size of its economy, as reserves are second lowest to Djibouti only
standing at 284 million U.S. dollars in 2000), the central bank should
be soon in a position to intervene more often on the exchange market,
both as seller and buyer, to prevent sharp short-term fluctuations in the
exchange rate. However, the central bank will aim at maintaining the
real effective exchange rate at a competitive level in the hope of
diversifying the export base. In addition, the BCM undertakes not to
carry out any longer exchange transactions outside the sessions of the
expanded foreign exchange market, which should encourage greater
participation on the part of banks.
Morocco: Over the 1990s, Morocco witnessed a decline in
competitiveness. It was deemed that in conjunction with structural
reforms and fiscal consolidation, a more flexible exchange rate policy
could play an important role in strengthening competitiveness and
spurring faster growth. The added competitive pressures that will result
from trade liberalization were highlighted in this regard. An alternative
belief is that, in light of the relative success of the current fixed
exchange rate arrangement in Morocco, the latter arrangement remains
appropriate when viewed against the strength of external accounts and
the need for preserving financial stability. Furthermore, productivity
gains realized as structural reforms take hold would improve
competitiveness (albeit it at a rate of change that is relatively slow). To
date, the monetary authorities haven’t succumbed to the pressure of
certain export sectors calling for devaluation of the dirham.
99
Palestine Authority97: Palestine is currently using three foreign
currencies. Should it continue to do so or launch a money of its own?
What are the economic implications of the choice? What conceivable
environment is likely to provide the basis for a self-sustaining
economy and a viable currency?
In the absence of a local currency, it is difficult, but not impossible, to
influence domestic monetary conditions. The instruments are largely
fiscal and regulatory. While there are many advantages, which a
country can exploit from having a national currency and being able to
determine its own monetary policies, certain benefits may accrue from
not having a national currency or domestic monetary policy options if
local situations and exigencies are not cooperative.
What is important in this regard is that a national currency should
never be introduced for symbolic, cosmetic or purely political reasons.
A national currency does confer on the national leadership
considerable power to influence a number of important economic
policy variables, such as exchange and interest rates, which in turn
affect levels of domestic liquidity, inflation rates, savings propensities,
the health of the financial sector, the balance of trade and levels of
investment. These are important determinants of national economic
97
The following assessment is based on the broad themes and recommendations
presented in a conference “On the Features of the Palestinian Monetary System”,
Cairo, Egypt. November 1999. Another good source for a discussion of the potential
monetary regime in Gaza and the West Bank is O. Dabbagh (1999).
100
development. Unfortunately, like all other policy instruments, illconceived monetary policy can also create huge economic distortions
and greatly damage the health and welfare of a nation if it is not
predicated on methodical research, prudent fiscal policies and, above
all, a strong independent central bank.
Also the timing of the introduction of a national currency is another
very important consideration. If having a national currency is a
prerequisite to the formulation of independent monetary policies, its
introduction should only be considered under circumstances of
political stability, good governance, and reasonable expectations of
economic growth. Public confidence in the capacity of the government
and central bank to manage the currency responsibly, and in the
soundness of the domestic banking system is essential. A cushion of
foreign assets also helps the cause.
The present state of the economy of Gaza and the West Bank does not
appear propitious for a new currency98. If the political problems
impeding development were to be solved while infrastructure
improvements continued, one might expect that domestic and foreign
investment would raise output and begin to generate export revenue to
reduce and ultimately eliminate aid dependence (which finances the
98
Because of transportation and security problems and the deteriorated state of the
infrastructure, Palestine is producing at less than the potential of its existing
resources. Despite relatively low wages coupled with relatively high level of
education for the region, uncertainty over the future political and economic
conditions has continued to discourage domestic and foreign investment.
101
bulk of current imports). In that environment, a new independent
currency could be viable. To make that potential a reality however, a
great deal needs to be done not only to build a new infrastructure but
also to develop an institutional framework to assure adherence to
budgetary discipline, by building an effective barrier against the use of
central bank credit to finance the government state enterprises, or
directed credit programs—as a best defense against inflations fueled by
government deficits, and to maintain a responsible monetary policy.
Establishing central banks and finance ministries that are committed to
price stability and economic reforms, along with a public willing to
support the commitments and to accept the new currency (by
exchanging their holdings of shekels, dollars and dinars for Palestinian
pounds) for the bulk of transactions and as a major store of value are
also critical in avoiding costs to the economy.
In this regard, the framework for macroeconomic policy should also
include sound, well-supervised banks, a monetary authority with a
well-trained staff for policy analysis as well as for supervision.
Arrangements of that kind should be in place and tested in operation
before a new currency is launched. Assurances that policy will
maintain price stability and sustainable growth are needed to stimulate
local investment, attract foreign capital and to induce Palestinians to
use the new currency as their primary monetary asset.
But before a currency is launched it is necessary to choose a currency
regime. The potential regimes (varying from dollarization to currency
102
boards to floating rates) are assessed in Box 5 in light of the exigencies
of the local economy and the implications of the choice for fiscal and
monetary policies are closely scrutinized. In summary, (1) it is
difficult, often painful, to maintain a fixed rate. The economic pain is
the same under an ordinary fixed rate regime or a currency board, but
the automatic decision rules of a currency board reduce the political
pain making a currency board more durable; (2) the real problem with
a fixed rate is that it may be maintained when it is no longer viable
without controls and that can prove very costly; (3) it is difficult to
manage a floating rate in a way which avoids costly instability but the
floating rate avoids the danger of being locked into the wrong rate.
Where do we go from here? It seems that maintaining the present
arrangements until the institutional framework is strengthened and the
competitive position of the economy established may be the best
option. The general piece of advice to Palestine Monetary Authority is
to proceed slowly, keep expectations low, and to prepare the ground
well before introducing a national currency. In the end, it is not the
currency that matters but rather it is the freedom which the currency
creates to implement policies which can, at best, help to fine-tune the
economy but, at worst, can lead to calamity.
103
Box 5. Potential Exchange Rate Regimes in the Palestine Authority
A currency board99 can build confidence in a new currency more readily than
a central bank. The currency board system appears to provide for a fixed
exchange rate without the need for the painful political choices required
under ordinary fixed rate regimes. In effect it builds the difficult choices into
the system. Its provisions provide assurance against the kind of government
sponsored inflation, which has caused so many currency disasters. While the
power of the fixed exchange rate guarantee is a great advantage in
establishing a new currency it is likely, in time, to cause difficulty. There are
after all times when the exchange rate ought to change: devaluation of the
currency of a major trading partner or persisting changes in terms of trade can
cause continuing balance of payments deficits. Given the uncertainty of
Palestine’s competitive position that is not an unlikely contingency. The
stronger the guarantee of a fixed rate the more difficult it will be to break the
contract. But to maintain it Palestine would have to undergo a painful fiscal
contraction and might nonetheless devalue.
A floating rate regime does not involve such dangerous commitments but it
not only permits but also requires some management of money supply and
interest rates. Even with very modest and cautious domestic management
objectives a central bank needs to be able to control money supply growth
and to respond to shocks affecting the exchange rate. Even when the
Palestinian authorities are ready to undertake those tasks it will be difficult to
achieve widespread acceptance for new currency whose value can change
from day to day. It is obviously difficult to launch a new currency without
some expectation that the currency will retain its value in the immediate
future. That is especially true when wealth holders have a viable alternative.
In establishing new currencies, many have advocated a preference for a
currency board, at least in the initial stages, over a floating rate regime. But
the dilemma here is that while a currency board regime makes a new
currency more acceptable than a floating rate regime, the fixed rate may
prove very costly. With the two proposed regimes being imperfect at best,
one wonders whether the present mixed up version of dollarization remains
the better alternative?
99
More general features of the Currency Board Arrangements are discussed further in
Box 6.
104
Box 5…continue
Dollarization like a currency board provides no way for monetary authorities
to exert much influence on the economy for good or ill. It protects against
government-sponsored inflation but does not provide for any influence on
money supply or interest rates. And, of course, there is no way for the
Palestinian authorities to change nominal exchange rate. If a change in real
exchange rate is needed it has to come about through changes in nominal
wages and prices brought about by supply and demand pressures and those
pressures will be exerted through Palestine’s competition in tradable goods
markets. That would also be true with a currency board but not with a
floating rate.
The difference between dollarization and currency board regimes arises from
the existence of a local currency and a monetary authority with reserves
which back the paper currency one for one but which do not back bank
deposits one for one. Trade developments or financial concerns which result
in a negative overall payments balance threaten the exhaustion of foreign
currency reserves. When actual dollars or other foreign currency are in use
outflows of that currency may bankrupt individual businesses or banks but
pose only an indirect threat to the whole system. Dollarization is therefore
much safer than currency board but is also expensive since it requires a large
investment in foreign currency or the payment of interest on borrowed
foreign currency.
105
Box 6. Currency Boards: General Features
A currency board can allow a developing country to establish its domestic
currency relatively promptly and efficiently by fixing the value of its
currency to that of another country and guaranteeing that its currency is
backed by sufficient foreign exchange reserves. Currency boards not only
provide a foundation that encourages traders and investors to accept new
currencies, they also do not require sophisticated money markets and central
banking operations in order to be effective.
Although, by design, they circumscribe the powers of their monetary
authorities, thereby shifting the responsibility for macroeconomic policy to
their fiscal authorities, these boards also promote a greater degree of fiscal
rectitude by denying their governments a ready supply of credit from their
central banks. The supply of base money grows only as rapidly as net foreign
trade and capital flows allow, thereby reducing the banking system’s capacity
to create money and credit in order to finance spending that exceeds its
economy’s resources.
Despite their merits, currency boards alone cannot ensure success. Although
they guarantee that their base money is backed by appropriate foreign
exchange reserves, confidence in the value of deposits, loans, assets, and
resources that are denominated in their currencies is limited by confidence in
the performance of their economies. A sound and healthy financial system
and an acceptable balance between government receipts and expenditures
through a responsible fiscal authority, support both the economy and the
currency. Captive capital markets (rather than reasonably efficient capital
markets that allow resources to flow to the most promising applications),
poor investments, or substantial government deficits can diminish an
economy’s prospects, foster capital outflows, and ultimately undermine the
value of its assets and currency.
A currency board requires a sound financial system because its ability to
conduct open market operations or to act as lender of last resort is, at best,
limited. The banking system, therefore, should be able to manage the
106
Box 6…continue
volatility of interest rates, assets’ values, and financing that can result from
the monetary authority maintaining a fixed exchange rate.
In highlighting the role of monetary policy under a currency board, the
operations of a currency board are confined to the exchange of its currency
for foreign currencies at the prescribed rate of exchange. As a result, a
currency board cannot assume the role of a full-service central bank. It has
limited capacity to serve as lender of last resort or to conduct open market
operations, deposit auctions, or other actions that alter the supply of base
money, except through the acquisition of its reserve currency. By design it
cannot influence employment, prices, and interest rates in its economy or the
volume of money, credit and capital flows.
Although currency boards can give currencies a quick start, they do not
necessarily provide a lasting foundation. To benefit most from a currency
board, an economy should use the temporary shield of this regime to prepare
for its potential departure. Although a currency board relieves its monetary
authority from the responsibility of executing its own policy, it also obligates
its monetary authority to prepare for its potential departure from the board.
To fulfill this obligation, its authority could install the data base, analytical
staff, and senior officials that it requires to study, debate, and adopt a
monetary policy. It also should develop its money markets and its financial
institutions’ ability to manage currency risks.
The two most important decisions for a currency board are its choice of
“reserve” currency, and its exchange rate. Setting the appropriate exchange
rate for an emerging economy’s currency is difficult because estimates of its
equilibrium value often are especially uncertain.
Source: Kopcke, R.W. (1999), “Currency board, once and future monetary
regimes?”
Sudan: Despite the virtual stability in the rate in 2000, there is no
evidence of a major pressure on the exchange rate. However, in view
of the many challenges and risks facing Sudan’s economy and the still
low level of international reserves (higher only to Djibouti), the
107
authorities are encouraged to allow the exchange rate to move flexibly
in response to market forces and not to allow any perception to develop
in the market that the rate was effectively fixed. In this regard, efforts
should be stepped up to further develop the interbank foreign exchange
market. The authorities are also encouraged to closely monitor
developments in external competitiveness, and, in particular, to avert
any threat of oil-induced strength in the exchange rate undermining the
competitiveness of the non-oil sector.
Syria100: As discussed previously, the official conventional pegged
rate in Syria applies only to a few debt payments relating to bilateral
payment arrangements101. In total, three official rates and two
unofficial rates exist in Syria. Without any doubt, unification of the
multiple exchange rate systems102 should be seen as a first essential
step toward reforming the exchange system. A clear plan needs to be
designed to bring about unification over a specific and appropriately
100
101
102
Restrictions maintained by Syria (and Libya) under Article VIII are not of the type
approved under the IMF jurisdiction. To be approved, the restrictions have to be
temporary, maintained for balance of payments reasons, and non-discriminatory.
While restrictions can be approved only if they are imposed for balance of payments
reasons, multiple currencies practices can be approved when they have been
introduced for non-balance of payments reasons “provided that such practices do not
materially impede the member’s balance of payments adjustment, do not harm the
interests of others, and do not discriminate among members.”
To be clear on the usage of terms of multiple exchange rate (MER) arrangements and
multiple currency practices (MCPs) in direct management of foreign exchange
transactions. The cost management approach (sometimes refered to as MCPs) in the
allocation of foreign exchange resources among different uses involves the
introduction of a variety of taxes, subsidies, and regulations, which can produce
effects on international transactions similar to those of the MER system.
Unification of exchange rate systems in Mauritania and Yemen was associated with a
move to floating exchange rate regimes.
108
brief period of time accompanied by a firm commitment to the
eradication of the multiple regimes.
Whether used for balance of payments purposes, or to raise tax revenue
through the exchange system, or to promote or discourage certain types
of transactions or sectors, or as a temporary measure before
liberalizing transactions, multiple exchange rate regimes have more
drawbacks than advantages. Experience with them shows that they can
distort economic incentives and impose costs on the economy by
misallocating resources for production and consumption. Moreover,
the maintenance of such systems generally requires a complex and
costly system of controls administered by using public sector
resources, and when administrative and institutional systems are weak
and scare resources are employed toward sustaining such systems,
foreign exchange pressures may reemerge, manifesting themselves
either directly through reserve losses or indirectly through a growing
informal sector—side effects that are all too familiar to the state of
economic affairs in Syria.
Tunisia: In as much as capital controls were likely to remain in
place103 and therefore, the exchange rate would continue to be largely
insulated from market pressures, the authorities’ emphasis on using the
exchange rate instrument to maintain external competitiveness is well
justified. As pointed out by the by IMF staff, the equilibrium real
exchange rate would be more difficult to predict in a situation where
trade liberalization (putting pressure on competitiveness) and
103
Tunisia registers the highest (KCI) index value (0.8) among all AMF members.
109
productivity gains (enhancing competitiveness) might proceed at
different paces. In this context, the CPI-based real exchange rate—the
main competitiveness indicator followed by the authorities in recent
years—was
likely
to
become
a
less
reliable
measure
of
competitiveness. The latest IMF mission urged the authorities to
develop and rely on a broader set of indicators to guide exchange rate
policy in the future, including export performance and unit labor cost
developments. The authorities indicated that already they had begun
following developments in relative market shares, and that the
departure from the real exchange rate targeting rule observed in 2000
reflected the perceived limitations of the CPI-based real exchange rate.
As for their foreign reserve objective, the general feeling is that a
sufficient cushion is in place against unforeseen events104. A last word
of caution on allowing a flexible exchange rate to benefit the export
performance in Tunisia. The central bank in 2001 has allowed the dinar
to depreciate more than required to maintain the real exchange rate in
order to compensate for the impact of the reduction in external tariffs
(under the Association Agreement with the European Union). This
should produce a favorable impact on the external balance. However,
to support this policy, the authorities must continue to adopt prudent
monetary and fiscal policies. Action on the exchange rate front is not a
substitute for the fiscal adjustment needed to redress external
imbalances.
104
A broader approach to reserve adequacy is sought in monitoring closely the reserve
coverage of short-term financial liabilities. Under the current reserve target for end2000, 90% of short-term liabilities (including debt coming due within one year)
would be covered. In view of the limited scope for portfolio outflows and the
generally stable nature of the deposits of non-residents, the mission deemed that this
ratio provided a sufficient safety margin.
110
Republic of Yemen: The improved external position helped stabilize
the exchange rate at about YRls 160 per US$ from mid-1999 through
late-2000, following a 13% depreciation in the first half of 1999. It is
observed that during 2000 one-sided intervention in the foreign
exchange market, by contributing to real appreciation of the rial, has
weakened incentives for tradeable goods production and diversification
away from oil. The authorities are advised to allow the exchange rate
to be fully market determined and limit intervention in the foreign
exchange market.
111
V. Conclusion
In tackling the question of an ideal exchange regime, we noted that an
optimal regime depended on policy makers’ economic objectives,
source of shocks and a tall order of other factors. The adoption of a
specific exchange regime was regarded as neither necessary nor
sufficient by itself to achieve the desired outcomes. Regardless of the
exchange rate arrangement, macroeconomic policies need to support
the arrangement to ensure its success. For instance, in a country
lacking financial discipline, macroeconomic problems will emerge
regardless of the exchange regime. Whatever exchange rate is in place,
it will only contribute to stabilization if macroeconomic policies are
sound and if structural reforms support macroeconomic policies.
For most Arab economies, we assumed throughout that the choice of
exchange rate regime is not simply one between a perfectly fixed and a
freely floating exchange rate. Rather, there is a range of regimes of
varying degrees of exchange rate flexibility reflecting different
intensities of official intervention in the foreign exchange market, and
different degrees of monetary policy independence. Consequently, in
debating a country’s monetary order, we emphasized a need to deal
with the configuration of the monetary order as a whole, and not
merely its exchange rate component. A central issue that usually
emerge in the topic of optimal exchange rates was how to best deal
with the tradeoff between the maintenance of internal monetary
stability and the constancy of the exchange rate in conducting
monetary policy, at different stages of the institutional development of
a country. In advising on desirable exchange rate regimes,
112
recommendations that were drawn have also embedded a dynamic and
a forward-looking view in light of changing considerations and
conditions overtime.
An important measure of competitiveness configured in the “real
effective exchange rate” was reviewed in the context of Arab
economies. A real appreciation trend was noteworthy in the recent
past. To the extent that this trend continues in the future, pressures on
the competitiveness of economies in the region will persist. For GCC
countries, although not totally shielded from competitiveness
pressures, the threat of appreciation on non-oil exports growth (the
only type of exports affected by cost competitiveness) is weak in light
of the competitiveness-enhancing productivity gains emanating from
low exchange and capital controls and from flexible labor markets
prevalent in the Council. As for the non-oil exporting economies, in
the absence of productivity gains, real appreciation may eventually
result in tighter profit margins in some export activities and
disinvestment in favor of domestic activities, further curtailing export
growth and possibly economic growth. Minimizing the effects of
decreased competitiveness on export growth will depend crucially on
the ability of these countries to continue to liberalize their economies
and their trade regimes, so that downward pressure on profits may be
alleviated by favorable movements in domestic prices, notably those of
imported inputs and labor. On the other hand, accelerating
privatization and creating a friendlier environment for foreign direct
investment would provide the technology and best managerial
practices necessary for productivity growth. The conclusion reached is
that an appropriate level of the REER and its medium-term path
113
depends upon the mix of monetary, fiscal and structural policies that
underpin the evolution of inflation, balance of payments, and
productivity growth.
In cases where floating exchange rate were contemplated, they were
advanced as the only way of preserving monetary policy autonomy in a
world where capital is completely mobile. Floating exchange rates are
also believed to relieve domestic prices and incomes from the full
burden of adjusting to changing conditions in world markets—
although not complete, a floating regime can at least partially assist its
economy’s adjustment to these outside pressures. Lebanon and Egypt
were two cases in mind where a shifting of the burden of adjustment
has shown elsewhere in the economy in less visible but damaging
forms as a result of policies that didn’t allow due adjustments in the
nominal exchange rate.
It was mentioned that productivity gains could mitigate real
appreciation in the currencies resulting in the loss of competitiveness.
On one hand, liberalizing the economies, pushing ahead with
privatization plans, and attracting foreign direct investment are all
policies that can increase productivity growth. However, implementing
such reforms take considerable time. On a parallel track, compensating
demand management policies such as contractionary monetary policies
and fiscal retrenchment, via lower domestic prices, can work to restore
some of the competitiveness lost to the overvalued currency. However,
good overall results achieved to date in the Arab region in curbing
inflation and fiscal responsibility limit the effectiveness of the related
demand policies. The deflationary trends appearing in a number of
114
Arab countries along with their associated negative effects on growth
make the adoption of flexible exchange rate regimes an attractive
alternative in improving competitiveness105.
In assessing the desirability of floating regimes in Arab economies, we
generally observed that the lack of monetary policy independence
associated with a fixed exchange rate system might be viewed as an
advantage, in light of the development stage of the monetary
institutions therein. Many Arab economies adopting a pegged
exchange rate to the U.S. dollar have rightfully acknowledged the
superior policy performance of the anchor country and the irrelevance
of their own independent policies, at least for the time being106. For the
AGCC group, it was noted that a flexible exchange rate is somewhat
redundant under a system of fiscal transfers, but at the same time we
expressed caution in the use of discretionary fiscal policy as effective
stabilization tools. Large fiscal deficits at times of low oil prices have
resulted in increased interest spreads, which have usually dampened
diversification efforts by curbing investment in non-oil sectors.
What about the state of affairs of the ‘traditional’ pegged systems in
Arab countries? For the case of the exchange rate systems in AGCC
countries, the effective or official pegging to the U.S. dollar has
resulted in stable currencies since the adoption of such regimes (as
105
106
For the signatories of AAEUs, an appropriate macroeconomic policy response is to
combine firm fiscal discipline, thus allowing room for exchange rate flexibility while
maintaining financial stability.
If domestic prices and wages were relatively flexible, a flexible exchange rate would
offer no advantage in terms of facilitating the adjustment process. A similar situation
would arise if factors of production, were perfectly mobile within (or across)
countries which reduce the need for domestic or external price adjustment.
115
early as 1979 in Qatar). In general such regimes have brought with
them strong guarantees of exchange rate constancy, despite few
episodes where large oil price fluctuations added pressures on the
currency peg (at least for one country in the Council). Lately, attention
has focused increasingly on making their economies more resilient to
terms of trade shocks107 by diversifying output and export composition.
In this vein of thinking, it is worth mentioning that the 1997-1998 oil
price downturn has triggered an adjustment strategy that sought to
fundamentally address structural weaknesses in the AGCC economies.
In mobilizing non-oil revenues as a central plan of the reform strategy,
facilitating sustained growth of the non-oil sector may require
vigilance in not allowing disequilibria in exchange rates to develop
which would likely undermine the competitiveness of would-be
products in world markets. On another front, regarding the viability of
a common currency, it was advised that the institutional and structural
characteristics and the way those countries respond to external shocks
be studied further.
As for the other (non-oil producing) Arab countries that have either
effectively or officially adopted a pegged system, the virtual stability
of the exchange rate has not managed to institute, at all times, a high
level of confidence in the constancy of the exchange rate. It is true that
107
The variability of the terms of trade of oil-producing countries has been the highest
among various groups of producers with a standard deviation close to 42 percent
between 1980 and 1998; for producers of non-oil products, primary products, and
manufactures, it was at most 6% in the same period.
Diversifying efforts in oil downstream activities and non-oil output growth will
undoubtedly be supported by an efficient infrastructure system in oil recovery
techniques and a network of comprehensive and modern services.
116
the constancy of such exchange rates have been observed, but the
pressing question here is at what costs has this been achieved. In
Jordan, Lebanon and Egypt (until just recently), the monetary policy
emphasis on the stability of the local currency has been right in light of
the specific circumstances. Nonetheless, although fixing the exchange
rates may have contributed to financial stability, the perceived
overvaluation of the real exchange rates came at the cost of high and
volatile real interest rates where sizable interest spreads shifted
investable resources from real (including exports) into financial
investments. We acknowledge that misalignments in equilibrium
exchange rates carry with them serious negative impact on the GDP
growth (in terms of reduction in economic efficiency, misallocation of
resources, and capital flight), disturbances to the economy that call for
early and necessary corrective realignments measures.
Final words regarding a pegged regime allude to the fact that a pegged
rate will only remain credibly constant if those administering will
exercise self-discipline in doing some things and abstaining from doing
others. In light of policy-makers’ continuous discretion in making
choices under a pegged regime, a lot is riding on the authorities’ ability
to reliably maintain an exchange system that is compatible with stable
markets expectations and confidence and hence with a viable overall
monetary order. Moreover, under a pegged system, intervention in the
foreign exchange market by the central bank would be as frequent as it
is necessary to keep the exchange rate in line—monetary authorities
are committed to stabilize the exchange rate. In contrast to a flexible
regime, under a pegged regime, priority ought to be given to the
constancy of the exchange rate (ahead of the maintenance of internal
117
monetary stability). But what must be observed, particularly in three
Mashreq economies (Jordan, Lebanon and Egypt), is a rationale calling
for exchange rate smoothing as a policy that is not aimed at resisting
market-determined movements in an asset price, but at mitigating
potentially destabilizing effects of abrupt changes in that price.
Otherwise, disadvantages of the fixed and pegged regimes in terms of
selling free insurance, discouraging risk assessment and hedging,
shifting burden of adjustment elsewhere and distorted asset allocation
process (Asia 1997) will eventually destabilize any economy in the
world.
118
Appendix A
Table A1. Factors Affecting the Choice of Exchange Rate
Arrangements
Economic Structure and Objectives
Desirable / Feasible
Very high inflation
Pegged or Flexible
Large external imbalances
Flexible
Low level of reserves
Flexible
Small size
Pegged
Openness
Pegged
Low flexibility of labor market
Flexible
Fiscal inflexibility
Flexible
Internationalization own currency
Flexible
Degree of dollarization
Pegged
Degree of financial development
Flexible
High mobility of capital
Flexible
Foreign nominal shocks
Flexible
Domestic nominal shocks
Pegged
Financial runs
Flexible
Real external or domestic shocks
Flexible
Policymakers’ objectives
Inflation reduction
Pegged
Correcting external imbalances
Flexible
119
Kuwait
Lebanon
Lybia
3
Egypt
Morocco
Mauritania
Yemen
-
-
-
*
-
*
*
-
-
*
-
-
*
-
*
* * * * * - * * * * * *
* * * * * * * * * * * *
* * * * * - * - * * * *
* - - * - - - - - * * -
-
*
*
*
*
* *
* *
* *
* -
*
*
-
-
* *
- -
*
*
*
*
*
*
*
*
*
*
*
*
UAE
-
Qatar
*
Oman
-
Iraq
Syria
*
-
-
Somalia
Sudan
-
-
Djibouti
- * * - - - - * - - - - *
Algeria
*
-
Tunisia
-
Bahrain
* - *
- -
* - - * *
- - -
Jordan
A. Exchange rate arrangements
1. Pegged exchange rate
- U.S. dollar
- SDR basket
- Special basket of currencies (not delared)
Saudi Arabia
Table A2: Exchange Rate Systems in Arab Countries-Year 2000
2. Floating exchange rate
- Managed float
- Independent float
-
-
-
-
-
3. Exchange rate structure
- Unitary for imports and exports
- Unitary for invisible transactions and captial transactions
B. Forward exchange market
C. Forward rates (on a commercial basis)
D. Acceptance of the obligations of IMF Articles of Agreement
- Article VIII: freedom of payments and transfers for
1
current international transactions.
- Article XIV: maintain restrictions on current payments.
*
*
Yes Yes Yes Yes Yes Yes Yes No No No No Yes Yes Yes Yes No No Yes Yes Yes
2
No No No No No No No Yes Yes Yes Yes No No No No Yes Yes No No No
* Indicates that the mentioned practice is a feature of the exchange system.
- Indicates that the mentioned practice is not a feature of the exchange system.
1 Article VIII, Section 2- requires member countries to avoid exchange restrictions on current payments; Section
3- requires members to avoid
discriminatory or multiple exchange currency practices; Section 4- permit the covertibility of foreign- held balances of its currency for current
2 Article XIV states that for a transitional period countries may maintain and adapt restrictions on payments and transfer for international transactions
that were in place when the country became a member of the IMF.
3 In fact, the country allows for the covertibility of current payments and transfers in part or in whole. However, the country has not officially accepted Article VIII.
Source: Data provided to the Joint Arab Economic Report for the year 2001; Annual Report on Exchange Arrangements and Exchange Restrictions (2000), IMF.
120
Table A3: Exchange Rate Arrangements and Anchors of Monetary Policy in Arab Countries
(as of December 31, 2000)
Monetary Policy Framework1
Hard
peg
Exchange Rate Regime (Number of Arab Countries)
(XI Regimes)
Exchange arrangements with no separate legal tender
(0)
Exchange rate anchor (14)
Another currency as legal
tender (I)
Djibouti*
(III) Currency board arrangement (1)
Other conventional fixed peg arrangements (including Against a single currency( 10 )
(IV)
de facto peg arrangements under managed floating )
Intermediate or
4,5
Pegged exchange rates within horizontal bands (1)7
Monetary
aggregate
target (2)
Inflationtargeting
framework (0)
IMF supported or
other monetary
program (5)
Other (3)
Monetary union (II)
Djibouti*
Against a composite ( 2 ) (V)
Bahrain
Comoros6
Iraq
Jordan* 4
Lebanon4
Oman
Qatar4,5
Saudi Arabia4,5
Syrian Arab Repulic3
United Arab Emirates4,5
Kuwait
Morocco
Within a cooperative
arrangement ERM-II (VI)
Other band arrangements ( 1 )
(VII)
Jordan*
Float
Libya
(VIIII) Crawling pegs ( 0 )4
(IX) Exchange rates within crawling bands 4
(X) Managed floating with no pre -announced path for
exchange
rate (5)
(XI) Independently floating (2)
Tunisia
Mauritania
Sudan
Yemen, Rep. of*
Yemen, Rep. of*
Source: IMF staff reports.
(21) Arab Countries are classified. The (number between parantheses) refers to the number of countries in that category. Roman numbers identify 11 separate categories.
1 A country with an asterisk, *, indicates that the country adopts more than one nominal anchor in conducting monetary policy . It should be noted, however, that it would not be
possible, for practical reasons to infer from this table which nominal anchor plays the principal role in conducting monetary policy.
2 The country has no explicitly stated nominal anchor but rather monitors various indicators in conducting monetary policy.
3 Member maintained exchange arrangements involving more than one market. The arrangement shown is that maintained in the major market.
4 The indicated country has a de facto arrangement under a formally announced policy of managed or independent floating. In the case of Jordan, it indicates that the country has
a de jure peg to the SDR but a de facto peg to the U.S. dollar.
5 Exchange rates are determined on the basis of a fixed relationship to the SDR, within margins of up to ±7.25 percent. However, because of the maintenance of a relatively stabe
relationship with the U.S. dollar, these margins are not always observed.
6 Comoros has the same arrangement with the French treasury as do the CFA franc zone countries.
7 The band width for Libya is (±77.5 percent),.
8 No relevant information is available for the country.
Algeria2
Egypt3
Somalia3,8
121
Box 2. New IMF Exchange Rate classification System
The new classification system is based on the members’ actual, de facto, regimes that may
differ from their officially announced arrangement. The system ranks exchange rate regimes
on the basis of the degree of flexibility of the arrangement. It distinguishes among the more
rigid forms of pegged regimes (such as currency board arrangements); other conventional
fixed peg regimes against a single currency or a basket of currencies; exchange rate bands
around a fixed peg; crawling peg arrangements; and exchange rate bands around crawling
pegs, in order to help assess the implications of the choice of exchange rate regime for the
degree of independence of monetary policy. This includes a category to distinguish the
exchange arrangements of those countries that have no separate legal tender. The new system
presents members’ exchange rate regimes against alternative monetary policy frameworks with
the intention of using both criteria as a way of providing greater transparency in the
classification scheme and to illustrate that different forms of exchange rate regimes could be
consistent with similar monetary frameworks. The following explains the categories.
Exchange Rate Regime
Exchange Arrangements with No Separate Legal Tender
The currency of another country circulates as the sole legal tender or the member belongs to a
monetary or currency union in which the same legal tender is shared by the members of the
union. Adopting such regimes is a form of ultimate sacrifice for surrendering monetary control
where no scope is left for national monetary authorities to conduct independent monetary
policy.
Currency Board Arrangements
A monetary regime based on an explicit legislative commitment to exchange domestic
currency for a specified foreign currency at a fixed exchange rate, combined with restrictions
on the issuing authority to ensure the fulfillment of its legal obligation. This implies that
domestic currency be issued only against foreign exchange and that it remain fully backed by
foreign assets, eliminating traditional central bank functions such as monetary control and the
lender of last resort and leaving little scope for discretionary monetary policy; some flexibility
may still be afforded depending on how strict the rules of the boards are established.
Other Conventional Fixed Peg Arrangements
The country pegs (formally or de facto) its currency at a fixed rate to a major currency or a
basket of currencies, where the exchange rate fluctuates within a narrow margin of at most ±1
percent around a central rate. A weighted composite is formed from the currencies of major
trading or financial partners and currency weights reflect the geo-graphical distribution of
trade, services, or capital flows. The currency composites can also be standardized, such as
those of the SDR and the ecu. The monetary authority stands ready to maintain the fixed parity
through intervention, limiting the degree of monetary policy discretion; the degree of
flexibility of monetary policy, however, is greater relative to currency board arrangements or
currency unions, in that traditional central banking functions are, although limited, still
possible, and the monetary authority can adjust the level of the exchange rate, though
infrequently.
122
Box 2…….continue
Pegged Exchange Rates Within Horizontal Bands
The value of the currency is maintained within margins of fluctuation around a formal or de
facto fixed peg that are wider than ±1 percent around a central rate. It also includes the
arrangements of the countries in the exchange rate mechanism (ERM) of the European
Monetary System (EMS)—replaced with ERM-II on January 1, 1999. There is some limited
degree of monetary policy discretion, with the degree of discretion depending on the band
width.
Crawling Pegs
The currency is adjusted periodically in small amounts at a fixed, pre-announced rate or in
response to changes in selective quantitative indicators (past inflation differentials vis-à-vis
major trading partners, differentials between the target inflation and expected inflation in
major trading partners, etc.). The rate of crawl can be set to generate inflation adjusted changes
in the currency’s value (“backward looking”), or at a preannounced fixed rate below the
projected inflation differentials (“forward looking”). Maintaining a credible crawling peg
imposes constraints on monetary policy in a similar manner as a fixed peg system.
Exchange Rates Within Crawling Bands
The currency is maintained within certain fluctuation margins around a central rate that is
adjusted periodically at a fixed preannounced rate or in response to changes in selective
quantitative indicators. The degree of flexibility of the exchange rate is a function of the width
of the band, with bands chosen to be either symmetric around a crawling central parity or to
widen gradually with an asymmetric choice of the crawl of upper and lower bands (in the latter
case, there is no pre-announcement of a central rate). The commitment to maintain the
exchange rate within the band continues to impose constraints on monetary policy, with the
degree of policy independence being a function of the band width.
Managed Floating with No Preannounced Path
for the Exchange Rate
The monetary authority influences the movements of the exchange rate through active
intervention in the foreign exchange market without specifying, or precommitting to, a
preannounced path for the exchange rate. Indicators for managing the rate are broadly
judgmental, including, for example, the balance of payments position, international reserves,
and parallel market developments, and the adjustments may not be automatic.
Independent Floating
The exchange rate is market determined, with any foreign exchange intervention aimed at
moderating the rate of change and preventing undue fluctuations in the exchange rate, rather
than at establishing a level for it. In these regimes, monetary policy is in principle independent
of exchange rate policy
123
Box 2 ….continue
Monetary Policy Framework
Members’ exchange rate regimes are presented against alternative monetary policy
frameworks in order to present the role of the exchange rate in broad economic policy and help
identify potential sources of inconsistency in the monetary-exchange rate policy mix.
Exchange Rate Anchor
The monetary authority stands ready to buy and sell foreign exchange at given quoted rates to
maintain the exchange rate at its preannounced level or range (the exchange rate serves as the
nominal anchor or intermediate target of monetary policy). These regimes cover exchange rate
regimes with no separate legal tender, currency board arrangements, fixed pegs with and
without bands, and crawling pegs with and without bands, where the rate of crawl is set in a
forward looking manner.
Monetary Aggregate Anchor
The monetary authority uses its instruments to achieve a target growth rate for a monetary
aggregate (reserve money, M1, M2, etc.) and the targeted aggregate becomes the nominal
anchor or intermediate target of monetary policy.
Inflation-Targeting Framework
A framework that targets inflation involves the public announcement of medium-term
numerical targets for inflation with an institutional commitment by the monetary authority to
achieve these targets. Additional key features include increased communication with the public
and the markets about the plans and objectives of monetary policy-makers and increased
accountability of the central bank for obtaining its inflation objectives. Monetary policy
decisions are guided by the deviation of forecasts of future inflation from the announced
inflation target, with the inflation forecast acting (implicitly or explicitly) as the intermediate
target of monetary policy.
IMF-Supported or Other Monetary Program
An IMF-supported or other monetary program involves implementation of monetary and
exchange rate policy within the confines of a framework that establishes floors for
international reserves and ceilings for net domestic assets of the central bank. As the ceiling on
net domestic assets limits increases in reserve money through central bank operations,
indicative targets for reserve money may be appended to this system.
Other
The country has no explicitly stated nominal anchor but rather monitors various indicators in
conducting monetary policy, or there is no relevant information available for the country.
124
Table A4: Country Scores on the FLT index, 1998
(19 Arab Countries)
Country
Bahrain
Comoros
Djibouti
Egypt
Iraq
Jordan
Oman
Qatar
Saudi Arabia
Syria
UAE
Lebanon
Kuwait
Libya
Tunisia
Yemen
Algeria
Morocco
Sudan
Source: H. Poirson (2001)
ME
0
0
0
0
0
0
0
0
0
0
0
0.001
0.003
0.001
0.006
0.008
0.011
0.009
0.027
MR
0.102
0.078
0.037
0.005
0.021
0.094
0.038
0.031
0.038
0.098
0.016
0.069
0.036
0.051
0.014
0.011
FLT
0
0
0
0
0
0
0
0
0
0
0
0.027
0.034
0.093
0.093
0.226
0.227
0.655
2.446
The degree of de facto exchange rate flexibility of country i (FLT) is measured by the ratio of
the average absolute value of monthly nominal exchange rate depreciation (ME) to the
average absolute value of the monthly change in reserves normalized by the monetary base in
the previous month (MR), in order to proxy for the monetary impact of these changes. FLT
assumes values ranging from zero to infinity, with the limits being defined by a perfectly
pegged policy at the one end (ME=0) and a completely intervention-free policy at the other
For country i:
11
∑
E −E
ME k=0
FLT=
=
MR 11
t−k
t−k−1
/E
t−k−1
∑
Rt−k −Rt−k−1 / Ht−k−1
k=0
wher Et = nominal exchange rate in month t, Rt = net international reserves, minus gold, in mo
and Ht = monetary base in month t.
125
Table A5: Exchange Rates: Domestic Currency per U.S. Dollar (period average)
(1992-2000)
Currency
of Arab
Countries
1992
1993
1994
1995
1996
1997
1998
1999
2000
2
2
Average annual
Average rate of
change rate in
change in the
the currency
currency value
value for the
during 1999period 19952000
2000
(%)
Jordan
UAE
Bahrain
Tunisia
Algeria
Djibouti
Suadi Arabia
Sudan
Syria 1
Dinar
0.6797
0.6929
0.6988
0.7008
0.7090
0.7090
0.7090
0.7090
0.7090
Dirham
3.6710
3.6710
3.6710
3.6710
3.6710
3.6711
3.6725
3.6725
3.6725
Dinar
0.3760
0.3760
0.3760
0.3760
0.3760
0.3760
0.3760
0.3760
0.3760
Dinar
0.8844
1.0037
1.0116
0.9458
0.9734
1.1059
1.1387
1.1862
1.3707
Dinar
21.8360
23.3450
35.0590
47.6630
54.7490
57.7070
58.7390
66.5740
75.2600
Franc
177.7210
177.7210
177.7210
177.7210
177.7210
177.7210
177.7210
177.7210
177.7210
Riyal
3.7450
3.7450
3.7450
3.7450
3.7450
3.7450
3.7450
3.7450
3.7450
Dinar
6.9444
15.3846
28.9610
58.0870
125.0790
157.5740
200.8020
252.5500
257.1200
Pound
28.2600
30.0600
33.0000
34.3600
39.2689
44.8792
49.2700
48.8304
49.0500
Shilling
…
…
…
…
…
…
…
…
…
Somalia
Dinar
0.3109
0.3109
0.3109
0.3109
0.3109
0.3109
0.3109
0.3109
0.3109
Iraq
Riyal
0.3845
0.3845
0.3845
0.3845
0.3845
0.3845
0.3845
0.3845
0.3845
Oman
Riyal
3.6400
3.6400
3.6400
3.6400
3.6400
3.6400
3.6400
3.6400
3.6400
Qatar
Dinar
0.2933
0.3013
0.2976
0.2985
0.2994
0.3033
0.3047
0.3044
0.3067
Kuwait
Pound
1,713.0748
1,741.4000
1,680.1000
1,621.4000
1,571.4000
1,539.5000
1,516.1000
1,507.8000
1,507.50
Lebanon
Dinar
0.2985
0.3224
0.3596
0.3532
0.3651
0.3891
0.3785
0.4616
0.5081
Libya
Pound
3.3303
3.3534
3.3868
3.3910
3.3900
3.3880
3.3880
3.4050
3.6900
Egypt
Dirham
8.5380
9.2990
9.2030
8.5400
8.7160
9.5270
9.6040
9.8040
10.6260
Morocco
Ouguia
87.0270
120.8060
123.5750
129.7680
137.2220
151.8530
188.4760
209.5140
238.9230
Mauritania
Riyal
28.5000
39.5400
55.2400
100.0000
128.0000
128.0000
135.8820
155.7180
161.7180
Yemen
1 The exchange rate of the U.S dollar in "neighboring country".
2 The average rate of change is calculated on the basic of U.S. dollar units per one local currency unit; The sign (-) refers to a depreciation in the local currency value.
Source: Data provided by Arab authorities to the Joint Arab Economic Report (2001), and the International Monetary Fund.
0.00
0.00
0.00
-15.55
-13.05
0.00
0.00
-1.81
-0.45
…
0.00
0.00
0.00
-0.77
0.02
-10.07
-8.37
-8.38
-14.04
-3.85
(%)
-0.23
-0.01
0.00
-7.15
-8.73
0.00
0.00
-25.73
-6.87
…
0.00
0.00
0.00
-0.55
1.47
-7.02
-1.68
-4.28
-11.49
-9.17
126
Table A6: Official International Reserves of Arab Countries *
(1995-2000)
( in millions
Total Arab Countries
1990
35757.9
1991
44163.7
1992
45611.9
1993
46586.8
1994
51666.86
1995
59099.16
1996
73082.97
Jordan
221
825
769
595.2
431.2
428.3
698
United Arab Emirates 4583.9
5365.4
5711.8
6103.7
6658.8
7470.9
8055.5
Bahrain
1234.9
1514.6
1258.7
1149.1
1103.5
1273.7
1264.7
Tunisia
794.8
789.9
852
853.8
1461.5
1624.6
1965.8
Algeria
725
1486
1457
1475
2674
2005
4235
Djibouti
73.76
72.16
76.97
Saudi Arabia
11668
11673
5935
7428
7378
8622
14321
Sudan
11.4
7.6
27.5
37.4
78.2
163.4
106.8
Syria
163
623
581
627
1087
1343
1709
Somalia
...
...
...
...
...
...
...
Iraq
...
...
...
...
...
...
...
Oman
1672.4
1663.3
1983.5
908.1
979.4
1137
1389.2
Qatar
667.7
683.3
693.7
694.4
727.6
631.1
667.7
Kuwait
3409
5146.9
4214.1
3500.7
3560.8
2419
3515.1
Lebanon
1275.5
1496.4
2260.3
3884.2
4533.2
659.9
5931.9
Libya
5694
4809
3357
3440
5640
5745.4
6794
Egypt
5325
10935.5
13039.8
13476
16192
2684
17400
Morocco
3100
3584
3655
4352
3601
2066
3794
Mauritania
67.6
61.2
44.6
39.7
85.5
54.1
141.2
Yemen
677.1
320.1
145
354.5
619
424
1017.1
*Excluding gold
Note: The total does not include Iraq and Somalia.
Source: - Data provided by Arab central banks to the Joint Arab Economic Report for year 2001.
- International Monetary Fund, Balance of Payments Statistics, Government Finance Statistics, Direction of Trade Statistics.
1997
81563.97
1998
79833.52
1999
85984.51
1693.3
8372.3
1362.2
1978.1
8047
66.57
14876
81.6
1624
...
...
1548.7
845.5
3451.7
5976.3
7572
18667
3993
200.8
1207.9
1170.3
9077.07
1349.2
1850.1
6846
66.45
14220
90.6
1860
...
...
1064.3
1445.6
3947.1
6556.3
6574
18113.5
4435
202.9
965.1
1991.1
10675.1
1371
2261.5
4543
70.61
16997
174.2
2110
...
...
2767.5
1277.5
4823.7
7775.6
7280
14480.5
5689
224.3
1472.9
127
Appendix B
Table B1: Dollarization Rates
(Foreign denominated deposits as a ratio of domestic liquidity )
end of December 1996 -2000
1996
1997
1998
1999
2000
UAE
Jordan
Saudi Arabia
19.9
16.2
17.0
19.6
15.1
16.4
20.0
18.8
17.9
21.2
19.0
16.4
22.4
21.3
15.6
Oman
Qatar
Kuwait
Lebanon
11.9
25.1
17.1
51.0
11.9
26.6
15.2
57.4
12.3
24.8
13.7
58.2
9.0
26.4
11.5
54.6
9.2
22.3
11.0
60.3
Egypt
20.4
18.0
17.3
17.7
20.1
Yemen
23.7
25.6
28.8
30.8
30.8
Source : Monetary and financial statistics bulletin
and Central Bank Surveys .
*According to available data from countries to date
( 2001) and Arab Monetary agencies
.
Table B2: Foreign Liabilities* in Arab Commercial Banks
(as a percentage of total liabilities )
end of period, 1996 -2000
1996
Jordan
UAE
Bahrain
Tunisia
Saudi Arabia
Syria
Oman
Qatar
Kuwait
Lebanon
Egypt
Morocco
Yemen
24.8
20.0
14.6
7.6
10.8
1.1
10.7
11.0
6.6
12.5
2.1
1.1
12.1
1997
22.6
22.5
19.0
7.6
16.3
0.5
15.2
12.1
9.6
14.0
3.4
1.4
18.7
1998
20.9
23.7
17.4
7.3
10.7
0.6
16.4
12.8
8.4
16.2
4.3
1.6
23.4
1999
20.2
22.5
23.1
8.6
12.3
0.8
16.7
9.4
15.8
3.7
1.6
24.0
2000
21.0
19.6
16.1
8.0
14.2
0.6
16.0
4.4
8.8
16.0
3.8
1.3
17.4
Source : Monetary and financial statistics bulletin
( 2001) and Arab Monetary agencis
and Central Bank Surveys .Foreign Libalities = Borrowing from foreign banks +
nonresidents deposits + other foreign liabilities .
*(Foreign denominated deposits of residents are not included
)
128
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